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The 


Foreign  Exchange 
Problem 

By  S.  STERN 
Vice-President  —  Columbia  Trust  Company 


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TRUST 

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Digitized  by  the  Internet  Archive 

in  2007  with  funding  from 

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http://www.archive.org/details/foreignexchangepOOsterrich 


The 

Foreign  Exchange 
Problem 

By  S.  Stern 

Vice-President — Columbia  Trust  Company 


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Copyright,  1921 

Colombia  Trust  Company 

New  York 

Second  Edition 


Foreword 

For  more  than  six  years  the  commercial  and  financial 
activities  of  the  world  have  been  more  or  less  seriously 
disturbed  by  the  spectacular  depreciation  and  the  violent 
fluctuations  in  the  prices  of  the  principal  foreign  currencies. 

What  will  be  the  final  outcome  of  this  perverse  and 
seemingly  chronic  condition  of  the  international  exchange 
markets? 

Day  after  day  the  banker  is  assailed  by  this  question. 
The  problem  is  one  of  the  most  vital  of  the  hour.  It  is 
not  only  of  direct  concern  to  our  people, — our  producers^ 
manufacturers,  importers,  exporters,  and  investors,  but  it 
also  affects  deeply  the  welfare  and  future  of  our  friends 
and  customers  abroad. 

As  a  contribution  to  public  thought  on  the  subject, 
we  offer  the  present  study  made  by  our  Vice-President, 
Mr.  S.  Stern.  He  has  been  assisted  in  connection  with  the 
research  work  and  in  the  preparation  of  the  charts  and 
tables  by  Mr.  H.  A.  Widenmann. 

WILLARD  V.  KING, 

President. 


March,  1921.  <— 

o 


456693 


TABLE  OF  CONTENTS 

Page 

I.    The  Foreign  Exchanges  up  to  the  Outbreak  of  the  World  War  1 

Basis  of  Foreign  Exchange 1 

International  Settlement  of  Accounts  in  Normal  Times 1 

Our   International   Balance   before    1914 2 

Course  of  Foreign  Exchange  under  the  Gold  Regime 2 

II.    The  Foreign  Exchanges  during  and  after  the  World  War 5 

Our    International    Balance   since    1914 5 

International   Settlements   since    1914 5 

Course  of  Foreign  Exchange  under  the  Paper  Regime 6 

Exchange   Fluctuations,   1914-1921 7 

III.  The  Present  Foreign  Exchange  Situation 10 

Potential  Supply  of  Exchange 10 

Potential  Demand  for  Exchange    11 

IV.  The  Real  Value  of  a  Foreign  Bill  of  Exchange  Today. 15 

New  Factor:    Price  Level  of  Goods 15 

Price  Level  of  Goods  under  the    Gold    Standard 16 

Price  Level  of  Goods  under  a    "Paper"    Regime 16 

When  are  Foreign  Exchanges  Actually  Depreciated? 17 

Causes  of  Undervaluation 18 

V.    Factors  which  have  Lowered  the  Foreign  Exchange  Quotations. . 

(a)  Currency  Disorders:     Inflation 23 

Inflation  and  the  Government 23 

Domestic  Regulation  of  Prices  and  Government  Subsidies..  24 

Inflation  and  Business 25 

Inflation  and  the  Banks 25 

Inflation  and  the  Money  Market 27 

Efi'ect  of  Inflation  on  Income 28 

Effect  of  Inflation  on  Bond  Values 28 

Ultimate  Effects  of  Inflation 29 

(b)  Trade    Disturbances:     83 

Relation  of  Exchange  to  Foreign  Trade 33 

Relation  of  Exchange  to  Particular  Lines  of  Business 84 

Exchange  and  the  American  Importer 34 

Exchange  and  the  American  Exporter 36 

Exchange  and  the  European  Importer 36 

Exchange  and  the  European  Exporter 36 

Exchange  Fluctuations  and  Future  Merchandise  Contracts..  37 

Exchange  Fluctuations  and  Price  Movements 39 

Effect  of  Real  Exchange  Depreciation  on  Foreign  Trade 39 

Effect  of  Export  Embargoes 41 

Effect  of  Special  Export  Prices  to  Foreigners. . . , 42 


TABLE  OF  CONTENTS 

Page 

Effect  of  Reduction  of  Foreign  Credits  on  U.  S.  Exports. . .  43 

Great  Britain's  Balance  of  Indebtedness 46 

Effect  of  Trade  Disturbances  on  the  Economy  of  the  United 

States 47 

(c)  SpecuicA.tiok:    51 

Factors  Favoring  Speculation 62 

VI.    Factors   which  will  Stabilize   or   Raise   the   Foreign   Exchange 

Quotations    57 

(a)  Credit:    67 

Credit  Funded  and  Unfunded   1914-1920 67 

Present  Attitude  respecting  Foreign  Short  Term  Credits ...  68 

Foreign  Funded  Obligations  held  by  the  United  States 69 

Foreign  Unfunded  Obligations  held  by  the  United  States ...  61 

Present  Attitude  respecting  further  Funded  Loans 62 

Prerequisites  to  the  Extension  of  further  Credits  or  Loans . .  68 
(Production,  Saving,  Taxation,  Yield,  Application  of  Loans) 

Exchange  and  the  Lender 66 

Exchange  and  the  Borrower 66 

Secured  Loans  to  Private  Borrowers 67 

Secured  Loans  to  Governments 69 

International  Situation  the  Overwhelming  Factor 70 

Europe's  Obligations  and  the  Future  of  Our  Foreign  Trade  70 

(b)  Deflation :    76 

Public  Economy   76 

Private  Economy   78 

Contraction  of  Currency 78 

Resumption  of  Gold  Payments  by  Deflation 79 

Inflation  by  the  United  States 80 

Cancellation  or  Repudiation 80 

Currency  Reforms  82 

VII.    The  Foreign^  Exchange   Outlook 85 

ADDENDA:     ^^ 

Historical  Survey  89 

Note  on  the  Charts 94 

Table  la — The  Principal  Foreign  Exchange  Rates 118 

lb— Annual  High  and  Low  Quotations  1914-1921 120 

2  — Comparison   between    Exchange    on    London    and    the 

actual  Purchasing  Power  of  the  Pound 122 

3  — Comparison  between  Exchange  on  Paris  and  the  actual 

Purchasing  Power  of  the  Franc 123 

4  — Comparison  between  Exchange  on  Berlin  and  the  actual 

Purchasing  Power  of  the  Mark 124 


LIST  OF  CHARTS 

Chart 
No.  Page. 

1— The  Visible  Trade  Balance  of  the  United  States 1 

2— The  Merchandise  Balance  of  the  United  States 4 

8 — United  States  Gold  Movements 9 

4 — Fluctuations  of  Sterling  Exchange 14 

5 — Fluctuations  of  French  Exchange 22 

6 — Gold  Reserves 26 

7 — Fluctuations  of  German  Exchange 82 

8 — Money  in  Circulation 88 

9 — Bank  Deposits 46 

10 — Index  Numbers  of  Prices 60 

11— United  States  Trade  with  the  United  Kingdom 68 

12 — Loan  and  Discount  Rates;  Great  Britain,  France 66 

13 — United  States  Trade  with  France 60 

14 — United  States  Trade  with  Germany 64 

15 — The  Merchandise  Balance  of  France 68 

16 — Loan  and  Discount  Rates ;  United  States,  Germany 74 

17— The  British  Merchandise  Balance 77 

18 — Public  Debt ;  Great  Britain,  France 81 

19— Public  Debt;  United  States,  Germany 84 

20 — French  Gold  Movements 88 

21 — Gold  Movements  between  the  United  States  and  France 88 

22— British  Gold  Movements 95 

28 — Gold  Movements  between  the  United  States  and  Great  Britain 96 

Gold  Movements  between  the  United  States  and  Germany 96 

24 — Government  Security  Quotations:     United  States     98 

25 — Government  Security  Quotations :    Great  Britain     100 

26 — Government  Security  Quotations:    France     102 

27 — Government  Security  Quotations :    Germany    104 

28— Gold   Premiums 106 

29— Boston  Exchange  on  London  1794-1833 108 

30— Baltunore  Exchange  on  London  1791-1829 110 


No.  1 


5    ;$    ^    ^    ^ 
^    5?    ^    95    ^ 

The  Visible  Trade  Balance  of  the  United  States 

BALANCE  (net)  of  the  merchandise,  gold,  and  silver  imports 
and  exports  between  the  United  States  and  the  rest  of  the  world 
annually  in  $1,000,000. 

Insert  reduced  to  l/lO  of  main  scale. 

A  general  note  on  the  charts  will  be  found  on  page  94. 


I 

The  Foreign  Exchanges  up  to  the 

Outbreak  of  the  World  War 

Basis  of  Foreign  Exchange 

Each  transaction  involving  a  settlement  of  accounts  between 
different  countries  calls  forth,  directly  or  indirectly,  demand  for, 
or  supply  of  foreign  currency.  A  demand  for  bills  of  exchange 
is  created  by  the  necessity  of  certain  individuals  in  one  country  to 
meet  obligations  in  other  countries.  These  obligations  arise 
from  merchandise  imported,  interest  charges  to  be  met  abroad, 
services  rendered  by  foreigners,  and  money  sent  or  loaned  abroad. 
A  supply  of  bills  of  exchange  is  created  for  converse  reasons. 

International  Settlement  of  Accounts  in  Normal  Times 

In  normal  times  the  method  of  liquidating  ultimate  balances 
between  countries  adhering  to  the  gold  standard^  is  the  ship- 
ment of  gold  from  the  debtor  to  the  creditor  country.^ 

(^)  Most  of  the  important  countries  have  adopted  a  monetary  system 
based  upon  what  is  called  the  gold  standard;  under  this  system  all  money 
circulating  in  the  country  entitles  the  bearer  to  a  certain  definite  quantity 
of  gold  which  he  can  obtain  upon  application  at  some  designated  govern- 
mental agency  (in  the  United  States,  at  the  Assay  Offices,  23.2  grains  of 
fine  gold  for  $1.00,  the  price  of  an  ounce  of  fine  gold  being  $20.67).  This 
gold  in  turn  has  a  definite  value  for  conversion  into  foreign  money  in  all 
those  countries  which  adhere  to  the  gold  standard.  This  system  enables 
an  individual  in  the  United  States  to  convert  his  paper  dollars  into  gold 
and  under  normal  conditions  to  obtain  for  this  gold  a  certain  definite  and 
invariable  amount  of  pound  notes  in  England,  franc  notes  in  France,  lire 
notes  in  Italy,  etc.,  and  vice  versa. 

In  this  study  we  have  not  referred  specifically  to  the  exchanges  of  those 
countries,  few  in  number,  which  are  still  on  a  silver  basis.  The  value  of 
the  silver  exchanges  in  the  gold  standard  countries  is  governed  by  the 
price  of  silver  metal  as  expressed  in  terms  of  gold. 

For  the  benefit  of  those  readers  who  are  not  entirely  familiar  with  the 
technical  questions  treated  in  this  paper,  we  have  endeavored,  in  so  far  as 
feasible,  to  explain  briefly  the  fundamentals  of  the  subject.  This  more 
elementary  material,  however,  we  have  tried  to  embody  in  footnotes,  so  as 
not  to  disturb  the  continuity  of  the  main  text. 

(')  Demand  and  supply  are  often  compensated  by  means  of  "arbitrage" 
between  the  various  countries ;  arbitrage  means  using  a  credit  balance  which 


-/2 : 


*     a^iti^, 


2  The  Foreign' Exchange  Problem 

Our  International  Balance  before  1914 

During  a  period  of  eighteen  years  (1896  to  1914)  the  pre- 
cious metal  flowed  into  our  country  at  the  average  rate  of  about 
$10,000,000  a  year,^  which  amount  represented  the  average 
credit  balance  in  our  favor  on  the  international  ledger.  Our 
exports  exceeded  our  imports  at  the  annual  average  rate  of 
$487,000,000;  this  merchandise  balance  combined  with  the 
money  invested  by  foreign  capitalists  in  our  country  offset  all 
the  debits  against  the  United  States  and  still  left  an  annual 
average  margin  of  $10,000,000  in  our  favor.  The  principal 
debits  against  the  United  States  were:  the  interest  charges  on 
the  continually  increasing  amount  of  foreign  capital  invested  in 
this  country;  the  indebtedness  incurred  by  immigrants  sending 
their  savings  back  to  Europe ;  the  money  spent  abroad  by  Ameri- 
can tourists  and  others.* 

Course  of  Foreign  Exchange  under  the  Gold  Regime 

As  long  as  a  country  is  able  and  wiUing  to  settle  the  balance 
of  its  foreign  debts  in  gold,  the  value  of  bills  or  credit  items 
payable  in  such  country  in  its  own  local  currency  is  tantamount 
to  a  legal  claim  on  the  equivalent  quantity  of  gold.    As  the  cost 

one  country  (United  States)  has  with  another  (Great  Britain)  to  liquidate 
a  debit  balance  which  said  country  (United  States)  has  with  a  third  country 
(France). 

(')  See  Chart  No.  1,  facing  page  1 ;  Charts  2  and  3,  pages  4  and  9. 
(*)  U.  S.  Balance  of  Indebtedness  1896-1914 

CREDITS  Annual  Average 

Excess  of  exports  of  mdse.  and  silver $487,479,000 

Net  Capital  borrowings  from  abroad 62,632,000 

*$640,111,000 
DEBITS 

Net  interest  payable  $160,000,000 

Tourists'  expenditures 170,000,000 

Immigrants'  remittances  150,000,000 

Net  freight  charges 33,737,000 

Net  imports  of  gold 9,153,000 

Insurance  premiums,  commissions  and  misc.  items 30,000,000 

*$652,890,000 
*No  balance  since  most  items  indeterminate. 

Source:     Harvard  Review  of  Economic  Statistics,  Vol.  1 — July,  1919. 
(Article  by  Charles  J.  Bullock,  John  K.  Williams  and  Rufus  S.  Tucker.) 


Foreign  Exchanges  up  to  the  Outbreak  of  the  World  War        S 

(freight,  insurance,  interest)  of  shipping  such  gold  to  the  credi- 
tor country  is  subject  only  to  slight  variations,  the  price  of 
foreign  bills  of  exchange  payable  in  countries  known  to  fulfill 
their  obligations  under  the  gold  standard  is  almost  fixed  and 
practically  stationary.  It  can  fluctuate  from  par"  only  to  the 
extent  of  the  shipping  cost.®  The  quantity  of  bills  offered  is 
normally  of  no  consequence.  Sufficient  demand  to  absorb  them 
is  created  automatically  through  the  banks ;  attracted  by  a  small 
margin  of  profit,  they  buy  the  excess  supply,  however  great,  and 
convert  it,  after  collection  in  the  debtor  country  into  gold  first, 
and  after  its  arrival  in  the  home  country,  into  their  own  cur- 
rency. 

This  was  the  situation  of  the  foreign  exchanges  up  to  the 
outbreak  of  the  war.  The  value  of  the  pound  sterling  (payable 
at  sight),  for  instance,  fluctuated  during  an  uninterrupted 
period  of  thirty-three  years  (1880-1913)  between  4?.82  and  4.91 
dollars;^  the  value  of  one  French  franc,  between  19.04  and 
19.60  cents  (5.25  and  5.10  francs  to  the  dollar)  ;®  the  value  of 
one  German  mark  between  23.57  and  24.07  cents  (4  marks  were 
quoted  between  94.3  and  96.3  cents).® 

(')  The  amount  of  one  currency  which  in  terms  of  gold  would  contain 
an  equal  quantity  of  fine  gold  as  the  unit  of  another  currency ;  thus  the  gold 
par  of  sterling-dollar  exchange  is  4.8666  and  $4.8666  of  gold  contains  as 
much  fine  gold  as  one  English  pound  of  the  same  fineness  as  the  U.  S. 
standard  dollar. 

(")  The  points  at  which  it  becomes  cheaper  to  export  gold,  after  making 
allowance  for  the  shipping  cost  (if  the  demand  for  bills  exceeds  largely  the 
supply)  or  to  import  gold  (if  the  supply  exceeds  largely  the  demand) 
rather  than  pay  the  higher  or  accept  the  lower  exchange  rate,  are  known 
as  the  gold  points. 

C)  See  Chart  No.  4,  page  14. 

n   See  Chart  No.  5,  page  22.  ' 

(*)  See  Chart  No.  7,  page  32;  also  the  Historical  Survey,  page  89. 


No.  2 


9$       35       ^ 


;:€     >     «^ 


^     S:     Q     Q     ^     ^     ^     ^ 


The  Merchandise  Balance  of  the  United  States 

BALANCE  (net)  of  imports  and  exports  of  merchandise  be- 
tween the  United  States  and  the  rest  of  the  world  annually  in 
$1,000,000. 

Insert  reduced  to  l/lO  of  main  scale. 

For  further  comment  on  this  chart  see  'page  112. 
[4] 


II. 

The  Foreign  Exchanges  during  and 

after  the  World  War 

Our  International  Balance  since  1914 

Since  1914  our  exports  have  expanded  on  an  unprecedented 
scale.  Growing  with  every  year  of  the  war,  our  trade  balance  in 
1919  aggregated  $4,017,000,000.  In  1920  it  amounted  to 
$2,949,000,000  in  our  favor.  Imports  from  abroad  decreased 
due  to  Europe's  lower  productive  capacity  and  difficulties  of 
navigation.  We  owed  less  for  what  in  banking  parlance  are 
known  as  "invisible  items" ;  viz.,  insurance,  freights,  and  expen- 
ditures of  American  tourists  abroad;  we  earned  considerable 
amounts  for  freight  carried  by  the  young  American  Merchant 
Marine. 

On  the  other  hand,  tremendous  amounts  were  spent  overseas 
by  the  American  Expeditionary  Forces  and  the  numerous  charity 
and  relief  organizations,  whose  activity  has  steadily  grown  since 
the  armistice;  moreover,  private  individuals  have  remitted  ap- 
preciably larger  sums  abroad.  Nevertheless,  the  annual  debit 
balances  against  Europe,  as  represented  by  an  excess  of  bills 
payable  by  her,  increased  vastly  with  every  year. 

International  Settlements  since  1914 

There  were,  for  a  while,  heavy  shipments  of  gold,^^  much 
more  important  than  the  annual  average  of  pre-war  years;  but 

(")  Total  Gold  Imports  and  Exports  (See  chart  No.  8.) 

A  1  TQij  J         Imports.  Exports.       Excess  Imports. 

Apr."    13  1917  f    $1,491,065,000        863,789,000        1,127,276,000 

At)t     13  1917 1  Excess  Exports. 

Dec*    10  1920 I        746,341,000     1,026,237,000  279,896,000 

Auff      1  1914—  )  Excess  Imports. 

Dec.    10  1920  .  \      2,237,406,000     1,390,026,000  847,880,000 

From  April  1917    to  the  end  of  the  war,  gold  movements  were  small. 

[5] 


6  The  Foreign  Exchange  Problem 

there  was  and  is  not  enough  gold  in  existence^^  to  settle  in  this 
manner  all  the  debts  incurred  by  the  various  foreign  borrowers, 
former  belligerents  and  neutrals.  Realizing  this,  the  various 
governments  early  in  the  war  imposed  embargoes  on  exports 
of  gold  and  have  not  officially  lifted  them  up  to  this  day/^  Their 
debts  were  met  in  the  major  part  by  the  liquidation  of  foreign- 
held  American  securities,^^  by  the  sale  to  us  of  foreign  short  and 
long  term  bonds,^*  by  direct  intergovernmental  loans  (the  Euro- 
pean governments  borrowing  from  our  government ),^'^  by  open 
account  credits,  and  the  acquisition  of  bank  balances  and  cur- 
rency.^* 


Course  of  Foreign  Exchange  under  the  Paper  Regime 

The  permanent  or  temporary  elimination  of  gold  as  a  final 
reserve  to  draw  upon  for  purposes  of  foreign  settlements  was 
bound  to  have  the  most  detrimental  effects  on  the  foreign  ex- 
change markets  of  the  world. 

In  the  European  markets,  both  because  of  enormous  pur- 
chases of  foodstuffs,  munitions,  and  war  materials,  and  also, 
by  reason  of  heavy  remittances  made  to  the  United  States  and 
neutral  countries  by  frightened  capitalists,  and  speculators,  the 
demand  for  the  dollar  and  neutral  currencies  increased  in  enor- 
mous proportions."    The  contrary  phenomenon,  of  course,  was 

Since  the  lifting  of  the  gold  embargo  by  the  United  States  in  June  1919, 
the  United  States  has  lost  much  gold  to  the  Orient,  while  little  has  come 
from  Europe  so  that  since  April,  1917  exports  from  the  United  States  have 
exceeded  imports  into  this  country. 

(")  The  present  gold  reserve  in  the  Central  Banks  of  Europe  aggregates 
less  than  $8,500,000,000.     See  also  Chart  No.  6,  page  26. 

(")  "With  the  exception  of  Great  Britain,  who  has  now  lifted  her  gold 
embargo  to  the  extent  of  permitting  new  gold  mined  in  her  colonies  to  be 
sold  in  the  open  market  and  exported.  Sweden  and  Norway,  during  the  war, 
imposed  an  import  embargo  on  gold,  and  Spain  bought  gold  at  a  discount; 
this  was  done  to  prevent  belligerents  from  further  flooding  their  country 
with  gold  in  return  for  commodities,  principally  foods,  which  were  grow- 
ing more  and  more  scarce. 

(")  To  the  extent  of  four  to  five  billion  dollars. 

(")  Which  holdings  are  estimated  to  amount  today  to  $3,000,000,000. 

(")  To  the  extent  of  about  $10,000,000,000. 

(")  The  total  of  these  three  items  has  recently  been  estimated  to  aggre- 
gate $3,600,000,000. 

(")  The  same  symptoms  were  noted  in  regard  to  the  pound  sterling 
which  appreciated  in  the  other  European  centers. 


Foreign  Exchanges  during  and  after  the  World  War  7 

experienced  in  the  neutral  markets  including  at  the  time  the 
American  exchange  centers.  Here  offers  of  the  currencies  of 
the  belligerents  accumulated,  due  to  supply  arising,  first,  from 
legitimate  trade  and  investment  sources,  and,  second,  from  spec- 
ulators who  in  the  removal  of  the  gold  cover  saw  a  point  of 
weakness  and  a  prospect  for  profit  on  the  short  side/^  Formerly, 
when  the  gold  points  were  exceeded,  the  banks  were  ready  and 
anxious  to  fill  the  gap  and  to  take  up  all  the  bills  offered.  This 
readiness  has  ceased  with  the  restriction  on  the  sale  and  export 
of  gold.  As  soon  as  the  actual  or  anticipated  needs  of  the  buy- 
ers for  immediate  or  future  delivery  are  filled,  the  excess  is 
forced  to  seek  an  outlet  at  a  price  \^^hich  will  depreciate  until 
new  demands  develop.  Such  new  demands  arise:  (1)  as  the 
lower  exchange  rates  facilitate  new  purchases  of  merchandise 
in  the  debtor  countries;^'  (2)  as  individuals  or  corporations, 
tempted  by  the  heavy  discount  on  the  former  quotations,  absorb 
the  available  exchange  material,  for  investment  or  speculative 
purposes.^^  In  the  absence  of  new  purchases  of  goods  on  the 
part  of  the  creditor  countries,  and  should  the  excess  of  bills  not 
be  absorbed  by  investment  or  speculation,  there  is  but  one  alter- 
native— a  decline  in  the  volume  of  exports  and/or  further  ex- 
change depreciation. 

Exchange  Fluctuations,  1914-1921 

This  was,  indeed,  what  actually  happened.  At  the  beginning 
of  the  war,  for  a  brief  period,  the  foreign  exchanges  rose  because 
we  had  to  cover  precipitately  short  term  loans  contracted  in 
Europe  (e.  g.  sterling  reached  $7.00  per  pound;  French  francs 
4.25  francs  for  the  dollar^23.52  cents  per  franc ;  German  marks 
$1.04  for  4  marks=26c.  per  mark).  With  this  exception,  the 
tendency  of  the  foreign  exchanges  has  been  steadily  downward. 
It  has  not  been  a  smooth  descent.    The  various  exchanges  fluc- 

(^*)  See  Chapter  V.  (c)  on  speculation. 

(^')  Where  prices,  unless  they  are  raised  to  the  same  extent  as  the  ex- 
change has  declined,  become  more  attractive  for  foreign  buyers,  thus  cre- 
ating a  basis  for  renewed  legitimate  trade. 

(^)  Either  in  the  shape  of  bills  of  exchange,  of  foreign  currency,  of 
transfers  to  their  credit  on  the  books  of  foreign  or  local  banks,  or  of  short 
or  long  term  internal  loans. 


8  The  Foreign  Exchange  Problem 

tuated,  at  times  very  violently.  The  supply  of,  or  demand  for, 
bills  expanded  or  contracted,  with  the  varying  fortunes  of  war 
and  the  evolution  of  politics.  The  paramount  question  before 
the  potential  buyer  of  a  foreign  bill  of  exchange  was  during  the 
war  and  will  be  for  some  time  to  come:  What  are  the  present 
political,  economic,  and  financial  conditions,  and  the  future  pros- 
pects of  the  country  whose  currency  is  offered?  Are  they  such 
as  to  render  reasonably  sure,  either  the  re-sale  with  profit  (or 
at  least  without  loss),  or  the  ultimate  settlement  in  gold,  goods, 
or  services'?  Those  countries  which  experienced  the  greatest 
internal  disintegration,  also  showed  the  most  extensive  exchange 
fluctuations.^^ 

CO  See  Table  No.  lb,  pages  120-121. 


No.  8 


iXX) 
ZX) 
TOO 

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so 

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so 

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United  States  Gold  Movements 


BALANCE  (net)  of  imports  and  exports  of  gold  between  the 
United  States  and  the  rest  of  the  world  annually  in  $1,000,000. 

Gold  imports  for  1920  are  shown  inclusive  of  108.5  millions  of 
gold  formerly  held  earmarked  for  account  of  the  Federal  Reserve 
Bank  by  the  Bank  of  England  and  returned  late  in  the  year  to  this 
country.  This  amount,  while  increasing  the  stock  of  gold  in  the 
United  States,  did  not  affect  the  balance  of  payments,  having  been 
placed  to  England's  credit  during  the  war. 

For  further  comment  on  this  chart  see  page  118. 


III. 
The  Present  Foreign  Exchange  Situation 

All  factors  influencing  the  exchanges  act  eventually  either 
through  the  supply  of,  or  demand  for  bills.  As  long  as  Europe 
obtained  credits  from  our  government  and  was  able  to  float  ex- 
ternal loans  or  receive  advances  in  various  forms  from  our  ex- 
porters, producers,  manufacturers,  speculators,  investors,  and 
banks,  there  was  a  more  or  less  sustained  demand  to  offset  the 
supply  of  export  bills  pressing  on  the  foreign  exchange  markets 
in  ever  growing  volume.  As  the  total  aggregate  of  the  foreign 
obligations  of  our  debtors  increased  and  their  borrowing  ability 
was  reduced,  because  of  the  higher  ratio  of  their  commitments, 
to  their  available  assets,  the  investment  and  speculative  demand 
for  foreign  bills  gradually  slackened. 

Potential  Supply  of  Exchange 

There  is  plenty  of  evidence  that  the  need  for  goods  continues 
unabated  in  Europe.  The  United .  States,  the  South  American 
republics,  and  Great  Britain,  to  a  certain  degree,  are  anxious  to 
fill  the  pressing  wants  ;^^  however,  before  current  risks  are  in- 
creased to  any  such  large  extent  as  will  be  necessary,  additional 
security  to  guarantee  the  repayment  of  further  obligations  is 
considered  essential.  Something  of  an  impasse  has  been  reached ; 
on  the  one  hand,  there  are  important  potential  consumers,  who 
are  urgently  in  need  of  goods,  but  who  have  already  amply  used 
their  credit  lines ;  on  the  other  hand,  there  are  important  poten- 
tial producers  anxious  to  strengthen  the  financial  status  of  their 
debtors,  and  at  the  same  time  to  increase  their  exports  to  them 
in  order  to  market  their  excess  production.  To  meet  her  heavy 
interest  obligations  and  to  pay  for  further  necessary  important 
quantities  of  raw  material,  commodities,  and  machinery,  Europe 

{^)  The  output  of  American  factories  for  the  twelve  months  ending 
June  80,  1920,  has  been  valued  at  $60,000,000,000,  or  about  40%  of  the 
estimated  total  of  the  world  ($120,000,000,000). 
[10] 


Present  Foreign  Exchange  Situation  11 

for  the  present  cannot  offer  gold  or  merchandise,  but  only  more 
paper  obligations — more  "long  term  foreign  biUs  of  exchange." 
This  condition  will  prevail  pending  such  time  as  Europe  is  able 
to  produce  and  export  goods  in  sufficient  volume  to  pay  for 
those  bought  and  imported. 

Potential  Demand  for  Exchange 

Whether  or  not  these  new  obligations  will  be  absorbed  will 
depend  first,  on  the  ability  and  willingness  of  certain  countries, 
particularly  our  own,  to  grant  the  necessary  large  additional 
credits  and  raise  the  important  amounts  required  for  loans; 
second,  on  the  guarantees — material  and  moral — ^which  the 
borrowers  will  be  able  to  offer  for  the  protection  of  their  past 
and  future  commitments. 

Inflation,  dislocation  of  trade,  and  impaired  credit — these 
have  been  the  determining  factors  in  the  break  of  the  exchanges 
since  1914.  Will  deflation,  adjustment  of  international  com- 
merce, and  regeneration  of  credit  result  in  a  reversal  of  recent 
foreign  exchange  history  during  the  period  in  which  we  are 
about  to  enter.?  With  the  foregoing  general  survey  of  the  sub- 
ject as  a  background,  it  is  proposed  to  search  out  the  possibil- 
ities for  such  a  development  and  determine : 

1st.     What  is  the  present  real  value  of  a  foreign 

bill  of  exchange.? 
2d:     What  are  the  factors  which  lower  its  real 

value.? 
3d:     What  are  the  factors  which  raise  its  real 

value.? 
4th:  Under  what  conditions  is  either  of  the  det- 
rimental or  favorable  groups  of  factors 
likely  to  exercise  a  decisive  influence  on 
the  movements  of  the  foreign  exchange 
markets  in  the  immediate  future? 

The  international  exchanges  are  a  delicate  mechanism,  gov- 
erned, as  has  been  stated,  by  the  demand  for,  or  supply  of 
foreign  bills.  As  a  result  of  the  war,  both  demand  and  supply 
are  influenced  more  directly  than  ever  before  by  commercial, 


12  The  Foreign  Exchange  Problem 

financial,  and  political  conditions.  Such  conditions  leave  their 
impress  on  the  exchange  markets.  The  resultant  rise  or  fall  of 
the  exchange  rates  often  causes — in  turn — by  way  of  more  or  less 
immediate  reaction,  changes  in  the  very  group  of  factors  which 
were  responsible  for  the  initial  movement.  Thus  it  will  be  found 
that  the  problem  of,  and  the  outlook  for  the  exchanges  are  inti- 
mately connected  with  the  present  state  and  the  probable  evolu- 
tion of  the  economic  life  and  relationships  of  the  various  coun- 
tries. As  we  deal  with  our  subject  it  will,  therefore,  be  necessary 
to  discuss,  both  from  the  theoretical  and  practical  standpoint,  a 
number  of  diverse  topics,  many  of  which  at  first  glance  would 
seem  to  have  little  or  no  bearing  upon  it. 


(Explanation  and  comment  referring  to  Chart  4  next  page.) 

Fluctuations  of  Sterling  Exchange 

Annual  high  and  low  quotations  of  60 


days  sight  rates  (number  of  dollars  per  £). 

Exchange    quotations    in    terms    of 

United  States  paper  currency  (computed  from  the 
gold  premium). 

1861-1864    exchange    quotations    in 

terms  of  gold   (computed  from  the  paper  quota- 
tions). 

The  quotations  for  the  years  1788  to  1790  are 
those  of  the  Philadelphia  market  (average  annual 
rate  only). 

Those  of  1791-1797  are  Baltimore  quotations. 

From  1798-1825  we  had  to  use  Boston  quota- 
tions; from  1826  on.  New  York  quotations  were 
available. 

1914  high  quotations,  more  or  less  arbitrary, 
having  been  computed  from  the  cable  rate  (60 
days  sight  rates  for  the  early  days  of  August 
1914,  not  available). 

Par:  4.44  4/9  up  to   1834 

4.87 1834-1837 

4.8666  ..  .since  1837 


1793     Crisis  in  England  and  outbreak  of  war  with 

France. 
1810     Crisis  in  England. 
1812     War  of  1812. 
1825     Crisis  in  England. 
1847     Crisis  in  England. 
1847-48     Political  disturbances   all  over  Europe; 

war  with  Mexico. 
1860     Large  excess  of  exports  from  the  U.  S. 
1866     Crisis  in  England. 
1873     World  crisis. 

1815     Crisis   and   depreciated  paper  in 
England  offset  by  disordered  cur- 
rency here. 
1837     Crisis  and  crop  failure  in  the  U.  S. 
1861-65     Civil  War. 

1869     Black  Friday — extensive  specula- 
tion in  gold  in  N.  Y. 
1879     Resumption   of   specie   payments. 
1914     Outbreak  of  Great  War;  Europe 
called  its  short  term  loans. 


[13] 


No.  4 


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FLUCTUATIONS    OF    STERLING    EXCHANGE 

For  explanation  and  comment  on  this  chart  see  previous  page. 


[14] 


iV. 

The  Real  Value  of  a  Foreign  Bill 
of  Exchange  Today 

"Cheap  money  is  always 
discounted  when  people  find 
that  it  is  cheap." 

All  foreign  currencies  or  accounts,  credits,  loans,  in  what- 
ever form,  can  ultimately  be  transformed  into  foreign  bills  of 
exchange.  As  we  have  seen,  prior  to  the  war,  a  foreign  bill 
of  exchange  represented  at  all  times  an  implied  and,  if  exercised, 
an  effective  claim  to  a  certain  quantity  of  gold  having  a  certain 
definite  and  legally  fixed  price  in  all  countries.  Now,  with 
the  suspension  of  gold  (specie)  payments,  the  holder  of  a 
foreign  bill  offers  to  the  prospective  buyer  merely  a  title  to  an 
equivalent  amount  of  paper  currency,  inconvertible  on  its  face, 
for  the  redemption  of  which  no  date  is  set  or  provision 
made.  Such  paper  currency  is  admitted  as  a  legal  means  of 
payment  (legal  tender),  only  in  the  country  in  which  the  bill 
is  payable.  The  buyer  of  a  foreign  bill  of  exchange  or  bank- 
note has  no  longer  the  option  of  converting  it  into  a  definite 
quantity  of  gold  as  formerly.  Therefore,  in  exchange  for  each 
dollar's  worth  of  foreign  currency,  the  American  buyer  (e.  g.) 
wants  to  be  able  to  obtain,  if  desired,  one  United  States  dollar's 
worth  of  merchandise. 

New  Factor:   Price  Level  of  Goods 

Theoretically  then,  the  bill  will  be  worth  just  as  much  as 
the  home  value  of  the  variable  quantity  of  goods  which  the 
buyer  may  be  able  to  acquire  with  it.  This  presupposes  that 
such  goods  are  permitted  to  be,  and  can  be  transported  out  of 
the  seller's  country  and  will  find  a  purchaser  in  another  country. 
In  other  words,  holders  and  buyers  of  foreign  bills  will  hence- 

[16] 


16  The  Foreign  Exchange  Problem 

forth,  whether  consciously  or  not,  appraise  their  value  accord- 
ing to  the  relative  price  level  of  goods  in  the  respective  coun- 
tries." 

The  price  levels  of  goods  in  the  various  countries  have  thus 
taken  an  unprecedented  importance  in  connection  with  the  course 
of  foreign  exchange.  It  is  necessary,  therefore,  to  consider  in 
detail  what  factors  influence  the  rise  and  fall  of  merchandise 
prices. 

Price  Level  of  Goods  under  the  Gold  Standard 

Before  the  war,  as  a  rule,  approximately  the  same  quantity 
of  the  same  merchandise  could  be  bought  in  most  countries  for 
the  same  amount  of  gold  or — ^as  gold  was  the  standard  adopted 
by  most  of  the  civilized  countries — for  the  equivalent  amount  of 
circulating  currency.^*  Of  course,  even  prior  to  191 4  a  certain  dif- 
ference in  price  levels  was  perceptible  in  all  countries.  Capital, 
merchandise,  and  labor  did  not  move  altogether  freely  from  one 
country  to  another  and  the  standard  of  living  varied.  Never- 
theless, Avithin  narrow  limits,  it  was  true  that,  barring  transpor- 
tation and  tariff  diff^erentials,  higher  prices  in  one  country 
would  immediately  stimulate  imports  to  that  country,  increasing 
the  supply  of  goods  there,  and  thus  tend  to  level  prices  once  more. 
Vice  versa,  lower  prices  in  another  country  would  stimulate  ex- 
ports from  that  country  and  thus  raise  prices  in  the  exporting 
country  or  lower  prices  in  the  importing  country,  or  both.  It 
will  thus  be  seen  that  the  gold  standard  and  freedom  of  com- 
merce, aided  by  the  co-ordinating  action  on  production  and  con- 
sumption ( resulting  from  the  free  flow  of  goods  and  credit  from 
one  market  to  another),  kept  price  levels  fairly  uniform^**  in 
all  those  countries  in  which  the  gold  standard  was  in  force. 

Price  Level  of  Goods  under  a  '*Paper**  Regime 

Europe  as  a  whole**  has,  for  the  time  being  at  least,  aban- 
doned the  gold  regime  and  resorted  to  an  inconvertible  paper 

(**)  The  speculator  will,  of  course,  also  consider  the  possibility,  however 
remote,  of  a  return  to  some  sort  of  a  gold  basis. 

(**)  See  footnote  No.  1,  page  1. 

(^)  See  Chart  No.  10,  page  50. 

l^)  This,  however,  applies,  with  certain  reservations  only,  to  those 
countries  which  were  not  participants  in  the  war. 


Real  Value  of  a  Foreign  Bill  of  Exchange  Today  17 

currency.  The  expansion  in  the  circulating  media  was  not 
counterbalanced  by  a  corresponding  increase  in  the  stock  of 
available  goods ;  rather,  due  to  the  diminished  productive  capac- 
ity of  the  warring  nations,  was  this  supply  decreased.  The 
resultant  shortage  of  merchandise  was  artificially  aggravated  by 
the  withholding  of  goods  from  the  markets  for  speculative  pur- 
poses. Moreover,  the  difficulties  of  communication,  deficiency 
in,  or  interruption  of  transportation,  and  vexatious  customs 
rulings  were,  in  some  instances,  responsible  for  violent  price 
fluctuations  and  excessive  premiums  on  urgently  needed  articles. 

It  was  inevitable,  therefore,  that  the  increase  in  paper  money 
should  result  in  an  unprecedented  rise  in  prices  in  Europe. 
In  our  country  there  has  also  been  inflation  (notwithstanding 
the  maintenance  of  the  gold  standard),  but  the  upward  move- 
ment of  prices  has  been  much  less  pronounced.^^  Thus,  as  prices 
ascended  more  and  more  in  Europe,  the  exchange  value  in 
United  States  dollars  of  the  individual  unit  of  European  cur- 
rency became  correspondingly  of  less  worth. 

Merchandise  having  been  virtually  adopted  as  the  common 
denominator  of  the  foreign  exchanges  and  currencies,  the  fall 
which  has  been  experienced  since  1914  was  to  a  certain  extent 
nothing  more  than  the  legitimate  result  of  an  eff^ort  on  the  part 
of  the  holders  and  buyers  of  foreign  bills  to  adjust  the  quo- 
tation of  such  bills  to  their  actual  merchandise  value.  For 
example,  as  prices  rose  in  France,  the  franc  would  buy  less  and 
less;  consequently  the  American  importer  paid  less  for  it.  To 
the  extent  that  the  foreign  exchanges  have  receded  from  this 
cause,  the  descent  was  natural,  necessary,  and  legitimate.  In 
order  to  allow  us  to  visualize  this  part  of  the  decline  more  clearly, 
we  shall  call  it  the  "gold  discount."  (The  purchasing  power  of 
gold  declines  as  a  greater  quantity  of  it  has  to  be  given  in  ex- 
change for  the  same  article.) 

When  are  Foreign  Exchanges  Actually  Depreciated? 

Actual  depreciation  exists  only  when  the  foreign  exchanges 
are  quoted  so  low  in  United  States  dollars  that  the  dollar  buys 
more  goods  in  Europe  than  here.  In  such  a  case,  the  American 
buyer  of  1000  francs  at  7  cents  a  franc,  should  he  convert  them 


18  The  Foreign  Exchange  Problem 

into  goods  in  France  and  ship  such  goods  to  the  United  States, 
will  realize  more  than  $70.  Conversely,  as  long  as  there  is  actual 
depreciation,  in  order  to  create  a  credit  balance  in  New  York  for 
goods  purchased,  the  French  importer  instead  of  paying  1000 
francs  at  home  for  a  $70  check  on  New  York,  will  find  it  more 
advantageous  to  ship  900  francs'  worth  of  goods  to  the  United 
States  and  sell  them  here  for  $70;  he  will  make  a  profit  of  100 
francs.  Again,  under  the  same  conditions,  the  American  ex- 
porter, instead  of  selling  for  $70  the  draft  for  1 000  francs,  which 
he  has  drawn  on  the  buyer  of  the  merchandise  exported  by  him  to 
France,  can  buy  1000  francs'  worth  of  merchandise  in  francs,  and 
sell  it  here  for  $77.  He  will  make  an  additional  profit  of  $7. 
This  depreciation  beyond  the  purchasing  power  value,^^  we  might 
call  the  "undervaluation." 

Our  problem  is  now  simplified.  We  distinguish,  in  consider- 
ing the  fall  and  the  eventual  restoration  of  the  exchanges,  be- 
tween the  justified  "gold  discount,"  as  reflecting  the  reduced  pur- 
chasing power  of  European  currencies,  and  the  temporary  and 
often  arbitrary  "undervaluation." 

Causes  of  Undervaluation 

This  "undervaluation"  or  real  depreciation,  as  we  shall  see 
hereafter,  is  or  may  be  due: 

First,  to  the  difficulty  of  establishing  with  exactitude  or  with 
even  a  fair  degree  of  approximation,  the  actual  purchasing 
power  of  foreign  currencies  in  terms  of  merchandise.^  The  daily 
changes  of  domestic  price  levels  of  merchandise  are  not  imme- 
diately reflected  in  the  foreign  exchange  markets,  but  only  after 
they  have  resulted  actually  in  foreign  sales  or  purchases.  Even 
if  the  prices  of  the  various  commodities  are  ultimately  levelled  in 
the  various  countries,  this  adjustment  does  not  take  place  at  the 

{")  The  point  at  which  two  different  currencies  are  theoretically  equal 
in  value,  as  expressed  in  merchandise,  has  been  called  the  purchasing  power 
parity. 

C^)  A  comparison  of  exchange  depreciation  with  prices  of  leading  com- 
modities, weighted  according  to  their  importance  (comparable  index  num- 
bers) would  show  the  extent  of  any  "undervaluation"  in  the  exchanges  of 
the  respective  countries.  However,  the  available  index  numbers  give  very 
inaccurate  results  for  such  purposes.  They  do  not  contain  the  same  com- 
modities and  they  are  constructed  differently.    For  our  purpose  they  should 


Real  Value  of  a  Foreign  Bill  of  Exchange  Today  19 

same  time  because  of  the  elimination  of  the  action  of  the  gold 
standard  and  money  rates  on  the  commodity  markets,  and 
because  of  the  impediments  to  free  commerce  between  the  various 
national  producing  and  consuming  centers. 

Second,  to  devices  and  regulations,  such  as  export  embargoes 
or  prohibitive  license  systems,  export  tariffs  (if  they  have  been 
imposed  by  the  debtor  countries),  the  practice  of  charging 
higher  prices  to  foreigners,  import  embargoes  or  tariffs  (if 
they  have  been  imposed  by  the  creditor  countries),  or  any 
other  general  or  actual  conditions  that  impede  the  free  flow  of 
commodities  which  normally  would  tend  to  harmonize  the  price 
levels. 


contain  only  those  goods  which  actually  or  potentially  enter  foreign  trade. 
Allowance  for  this  should  be  made  in  drawing  conclusions  from  Tables 
Nos.  2,  3,  and  4,  (pages  122,  123,  124) . 

,  Perhaps  the  speculative  tendencies  and  the  fluctuations  in  the  exchange 
markets  to  which  we  have  referred  might  be  curbed,  to  a  certain  extent, 
if  all  countries  published  weekly  special  index  numbers,  on  a  compar- 
able basis,  showing  the  average  c.  i.  f.  prices  of  those  commodities  which 
rank  most  prominently  in  their  foreign  trade  with  each  of  the  other  coun- 
tries. For  instance,  the  proper  agencies  in  our  country  would  prepare 
this  special  "exchange  index"  for  Great  Britain,  France,  Belgium,  Italy,  etc., 
and,  vice  versa,  we  would  receive  the  "exchange  index"  from  each  of  these 
nations.  A  comparison  between  the  two  indeces  arrived  at  by,  for  example, 
the  United  States  and  Belgium,  respectively,  should  then  show  approxi- 
mately to  what  extent  prices  of  merchandise  exported  from  either  the 
United  States  or  Belgium  are  higher  or  lower  in  one  country  than  in 
the  other.  Such  a  comparison,  if  its  results  were  given  wide  publicity 
at  regular  intervals,  would  call  the  attention  of  bona  fide  holders  of 
foreign  exchange  to  the  actual  purchasing  power  value  of  the  various  cur- 
rencies and  would,  in  many  instances  probably,  prevent  them  from  dumping 
their  holdings  on  the  markets,  or  induce  them  to  delay  their  sales  until  such 
moment  when  the  temporary  "undervaluation,"  due  to  the  various  causes 
which  we  have  discussed,  has  been  reduced. 

Along  similar  lines,  it  would  perhaps  also  be  worth  while  to  consider 
whether  one  part  of  the  excellent  work  done  during  the  war  by  the  Division 
of  Foreign  Exchange  of  the  Federal  Reserve  Board  should  not  be  per- 
petuated in  some  form,  and,  with  the  cooperation  of  the  proper  foreign 
agencies,  generalized  so  as  to  include  all  the  leading  countries:  we  refer 
to  the  weekly  statistics  showing  the  total  amount  of,  for  instance,  the  dollar 
balances  held  in  the  United  States  by  foreign  correspondents,  the  balances 
held  abroad  in  foreign  currencies  by  American  banks  and  business  con- 
cerns, and  their  holdings  in  foreign  bills  and  securities. 

These  figures,  if  regularly  published,  would,  perhaps,  go  a  long  way  to 
dispel  the  mystery  in  which  the  movements  of  capital,  and  the  changing 
balances  of  indebtedness,  are  shrouded  today,  because  of  the  lack  of  suitable 
relcords. 


20  The  Foreign  Exchange  Problem 

Third,  to  the  fact  that  capital,  because  of  the  uncertain 
credit  situation  abroad  or  because  of  temporarily  stringent  con- 
ditions at  home,  is  less  willing  to  take  advantage  of  more  re- 
munerative possibilities  of  employment  in  Europe;  furthermore 
to  the  fact  that  speculation  anticipates  differences  in  price  levels ; 
i.  e.,  differences  in  purchasing  or  producing  capacity,  changes 
in  tariflPs,  taxes,  and  shipping  costs. 

Dispensing  for  the  moment  with  a  more  detailed  discus- 
sion of  these  factors,  we  may,  nevertheless,  draw  this  obvious 
conclusion:  The  real  value  of  a  foreign  hill  of  exchange  today 
is  its  actual  purchasing  power  value,  as  expressed  in  terms  of 
merchandise.  The  exchanges  cannot  he  permanently  depressed 
below  that  purchasing  power  value.  At  some  time  or  other 
initiative  will  revive.  Present  obstructive  trade  regulations, 
wherever  they  exist,  will  he  removed.  The  more  progressive 
and  farsighted  business  men  will  then  take  advantage  of  any 
abnormal  differences  i/n  the  prices  of  goods  to  engage  in  new 
purchases.  The  more  aggressive  capitalists  and  the  hankers, 
supported  by  an  intelligent,  efficient,  and  energetic  administra- 
tion, will  always  at  the  proper  moment  play  their  traditional 
role  of  pioneers  in  the  marts  of  the  world  and  thus  help  to 
restore  to  their  purchasing  power  value,  those  exchanges  which 
are  actually  depreciated. 


(Explanation  and  comment  referring  to  Chart  5  next  page.) 

Fluctuations  of  French  Exchange 

Annual  high  and  low  quotations  of  60 


days  sight  rates    (number  of  francs  per  dollar). 

Exchange    quotations    in    terms     of 

United  States  paper  currency  computed  from  the 
gold  premium. 

1861-1864    exchange    quotations    in 

terms  of  gold,  computed  from  the  paper  quotations. 

1921    quotations    to    February    18th 

only. 

Average  annual  quotations  only  for  the  years 
1789-1792,  1815,  1818-1820. 

Philadelphia  quotations  up  to  1825. 

New  Orleans  quotations   1846-1849. 

1914 — high  quotations  more  or  less  arbitrary, 
having  been  computed  from  the  cable  rate  (60  days 
sight  rates  for  the  early  days  of  August  1914,  not 
available) . 

Furthermore,  from  188S,  whenever  there  were 
no  60-days  sight  quotations,  they  were  computed 
from  sight  or  cable  rates. 

Insert  reduced  to  1/8  of  main  scale. 

Par  5.18. 

Par  in  first  part  of  the  last  century  actually 
5.34;  practically,  considering  French  seignorage 
charges  it  was  about  5.26. 

1789  French  revolution — financial  disorders 
which  came  to  a  climax  in  the  terrific  crisis 
of  1796  brought  about  by  the  excessive 
issues  of  assignats. 

1826  Commercial  depression  in  Europe,  especi- 
ally England. 

1830     Political  disturbances. 

1847-48  Political  disturbances  all  over  Europe; 
war  with  Mexico. 

1860     Large  excess  of  exports  from  the  U.  S. 

1866     Crisis  in  England. 

1815-16     Currency    disorders    here    offset 
financial    and    political    situation 
in  Europe. 
1837     Crisis  and  crop  failure  in  U.  S. 
1861-65     Civil  War  in  the  U.  S. 
1870-1        Franco-Prussian  War. 
1914     Outbreak  of  the  Great  War;  Europe 
called  its  short  term  loans. 


[21] 


No.  5 


FLUCTUATIONS  OF  FRENCH  EXCHANGE 

For  explanation  and  comment  on  this  ^chart  see  previous  page. 


[22] 


V. 

Factors  which  have  Lowered  the  Foreign 
Exchange  Quotations 

(a)   CURRENCY  DISORDERS:  INFLATION. 

We  have  found  that  the  most  important  factor  explaining 
the  heavy  dedine  of  the  gold  value  of  European  monetary  units 
is  the  rise  in  prices  of  merchandise  in  Europe ;  furthermore,  that 
this  rise  of  prices  is  chiefly  due  to  the  expansion  of  circulating 
media.^® 

Inflation  and  the  Government 

This  increase  was  caused  primarily  by  government  expendi- 
tures for  military  and  reconstruction  purposes.  For  almost  seven 
years  most  of  the  European  governments,  with  the  single  excep- 
tion perhaps  of  Great  Britain,  have  spent  more  than  they  have 
raised  by  their  current  annual  revenues.  In  so  far  as  governments 
paid  for  their  purchases  in  new  currency  without  collecting  cor- 
responding amounts  in  taxes  coming  from  actual  savings  of  the 
citizens,  there  was  bound  to  be  inflation.^^  Where  the  govern- 
ments did  not  actually  print  paper  money,^^  inflation  was 
achieved  through  various  indirect  means,  as,  for  instance,  bor- 
rowing from  the  note-issuing  banks  on  open  account,  or  against 
short  or  long  term  treasury  bills,  or  by  way  of  the  flotation  of 
internal  loans. 

(*)  For  our  purposes  we  may  include  in  this  term:  I.  Currency,  (a) 
Coins  other  than  gold;  (b)  paper  money,  being  the  obligation  of  either  the 
government  or  the  banks  of  issue;  II.  Bank  credits  or  deposits  with  which, 
by  means  of  checks,  payments  are  made;  III.  Bonds  of  internal  loans  and 
postage  stamps  in  so  far  as  they  are  used  instead  of  currency — ^in  short, 
anything  that  is  being  used  as  an  instrument  of  payment. 

(**)  Increase  in  circulating  media  without  corresponding  increase  in 
gold  or  goods. 

(«*)  See  Chart  No.  8,  page  88. 

[23] 


24  The  Foreign  Exchange  Problem 

Domestic  Regulation  of  Prices  and  Government  Subsidies 

Another  important  factor  in  the  continuous  process  of  in- 
flation was  the  endeavor  to  keep  prices  of  certain  products 
below  the  level  which  they  would  normally  have  attained.  In 
this  category  belong  the  practices,  in  many  cases  inevitable,  of 
fixing  legally  maximum  prices  on  coal,  sugar,  bread,  etc.,  as  well 
as  selling  certain  articles  or  services,  e.  g.,  railroad  transporta- 
tion, below  cost.  When  such  price-fixing  was  found  to  be  in- 
sufficient to  relieve  the  population  from  the  continually  climb- 
ing merchandise  prices  of  commodities,  certain  classes  in  the 
community  were,  in  addition,  granted  business  or  unemployment 
bonuses  or  allowances.  With  some  commodity  prices  artificially 
low,  the  consumption  of  goods  was  maintained  on  a  high  level 
except  in  such  cases  where  the  supplies  to  individuals  were  ra- 
tioned or  where  the  public  responded  to  patriotic  appeals  for 
economy.  In  normal  times  the  higher  prices  would  have  reduced 
consumption  ipso  facto.  During  the  abnormal  war  years, 
people,  on  the  one  hand,  consumed  more,  while,  on  the  other, 
the  pressure  to  produce  more  was  relaxed.  The  government 
expenditures  involved  in  price-fixing  and  similar  schemes  have 
been  considerable.  The  various  governments  to  a  greater  or 
lesser  extent  have  been  unable  to  acquire  enough  real  savings  by 
taxation  or  borrowing  to  meet  these  large  outlays. 

Thus  government  expenditures  of  all  kinds  contributed  to 
make  the  total  fiscal  commitments  so  expensive  for  the  treasuries 
that  the  only  alternative  open  to  them  was  to  resort  to  the  crea- 
tion of  new  banknotes  or  to  borrow  additional  excessive  sums 
from  the  banks  or  the  people  with  the  same  ultimate  eff^ect.^^ 

C")  During  the  war  the  volume  of  paper  money  in  circulation  in  the 
world  increased  annually  at  the  rate  of  $9,000,000,000.  In  the  first  year 
after  the  armistice  the  increase  amounted  to  $12,000,000,000  and  in  the 
second  to  $26,000,000,000.  In  the  year  1913,  the  paper  money  in  circulation 
all  over  the  world  amounted  to  $7,500,000,000;  now  it  has  risen  to  $82,000,- 
000,000.  The  ratio  of  gold  to  paper  circulation  was  66.8%  in  1918;  at  the 
time  of  the  armistice  it  stood  at  17.6%  and  has  now  fallen  to  9.2%.  The 
public  debt  of  the  nations  amounted  in  1913  to  $43,000,000,000;  it  amounts 
today  to  $300,000,000,000.  Before  the  World  War  the  interest  service  of  the 
public  debt  demanded  $1,760,000,000  annually.  Now  more  than  $12,000,- 
000,000  is  required.  (For  all  these  figures  the  1913  currency  values  have 
been  employed.  The  paper  emissions  and  financial  transactions  of  Soviet 
Russia  are  not  included.)     Source:    The  Americas. 


Factors  which  have  Lowered  the  Foreign  Exchange  Quotations  26 
Inflation  and  Business 

The  increase  of  commercial  and  private  demand  for  capital 
and  credit  during  and  after  the  war  has  been  another  factor 
responsible  for  inflation.  Business  houses  and  individuals  had 
to  raise  important  amounts  in  order  to  pay  the  heavily  increased 
taxes  or  to  subscribe  to  government  loans.  To  the  extent  that 
this  was  done  without  either  reducing  consumption  or  enlarging 
production  (thus  creating  savings),  to  the  extent  that  revenues 
were  not  increased  or  investments  disposed  of,  the  banks  were 
called  upon  for  advances,  loans,  or  credits.  In  other  words,  in  so 
far  as  tax  receipts  or  loan  subscriptions  did  not  come  from  new 
real  savings,  there  was  necessarily  further  inflation. 

Inflation  and  the  Banks 

In  normal  times,  most  of  the  paper  money  and  checks  put 
into  circulation  find  their  way  back  to  the  banks  after  a  rela- 
tively short  circuit.  They  pass  through  the  hands  of  the  pro- 
ducers, manufacturers,  and  distributers  who  have  furnished  raw 
materials  or  finished  goods  to  the  government  or  private  con- 
sumers, and  through  the  hands  of  those  who  have  labored  either 
for  the  government  or  individuals.  Sooner  or  later  they  come 
back  to  the  banker  in  the  form  of  cash  deposits  made  by 
any  of  these  classes. ^^  There  is  thus  a  normally  continuous 
large  stream  of  deposits.  Inflation  has  tremendously  expanded 
this  volume  of  deposits.^* 

The  heavier  liabilities  involve:  1st,  increased  capital  and  sur- 
plus on  the  part  of  the  banks  in  order  to  furnish  to  their  cus- 
tomers proportionally  greater  guarantees  for  the  proper  admin- 
istration of  their  larger  deposits;  Snd,  additional  investments, 
either  in  the  form  of  commercial  bills,  or  loans  on  securities  or 
merchandise,  or  short  term  treasury  bills;  3rd,  as  far  as  these 
deposits  emanate  from  business  firms  or  corporations,  they  are 
used,  when  necessary,  as  partial  guarantees  for  loans  required  for 
the  extension  or  development  of  their  trade. 

(^)  During  the  war  the  practice  of  hoarding  money  once  more  became 
prevalent  in  order  to  avoid  the  payment  of  taxes  or  capital  levies. 
(")  See  Chart  No.  9,  page  46. 


No.  6 


I      I     I     I     I 


Gold  Reserves 

Bank  of  England:      (3)    Average  annual  holdings  of  gold  coin  and 
bullion  in  £1,000,000. 

Bank  of  France:     (2)  Average  annual  holdings  of  gold  and  silver  coin 
and  bullion  in  100,000,000  Francs. 

— . — . — .  Average  annual  holdings  of  gold  coin  and  bullion  in  100,- 
000,000  Francs. 

Bank  of  Germany:     (1)    Average  annual  holdings  of  gold  coin  and 
bullion  in  10,000,000  Marks. 
[26] 


Factors  which  have  Lowered  the  Foreign  Exchange  Quotations  27 

The  banks,  guided  by  patriotic  and  business  motives,  were  in- 
duced to  satisfy  the  demands  for  credit  on  the  part  of  the  gov- 
ernment and  the  industrial  community  as  liberally  as  the  due 
regard  for  the  interests  of  their  depositors  would  permit.  The 
governments  were  obliged  to  repeat  their  appeals  with  greater 
and  greater  frequency.  Private  enterprises  borrowed  in  order 
to  enlarge  plant  and  output,  both  for  the  public  benefit  and  for 
their  own  personal  advantage.  Thus  a  new  factor  making 
for  increased  buying  capacity  was  given.  In  addition,  competi- 
tion among  banks,  facilitated  in  some  instances  by  the  removal 
of  bank  reserve  requirements  or  by  the  more  liberal  discount 
policy  of  the  central  reserve  banks,  has  brought  about  in  Europe 
less  discrimination  and  less  inclination  than  under  normal  con- 
ditions to  restrict  and  reduce  credits.  Even  this  situation  is  due 
in  a  measure  to  unwise  government  finance.  When  the  state  ab- 
sorbs the  savings  of  the  people,  and  when  the  community, 
prompted  by  a  sense  of  self-preservation  and  a  desire  for  con- 
tinuous progress,  calls  for  unhampered  agricultural  and  indus- 
trial expansion,  the  banker  in  times  of  national  emergency  may 
be  expected  to  lay  aside  some  of  his  natural  conservatism. 

Inflation  and  the  Money  Market 

These  demands  for  commercial  and  private  credit  were  the 
more  pressing  as  the  brakes  formerly  applied  in  the  form  of 
higher  rates  of  interest  could  not  be  sufficiently  used,  especially 
during  the  war.  The  governments,  in  order  to  float  new  and 
fund  old  loans  under  favorable  conditions,  were  primarily  in- 
terested in  maintaining  low  rates  ;^''  moreover,  in  certain  cases, 
they  desired  to  veil  the  deterioration  of  their  credit.  Industry, 
on  the  other  hand,  is  generally  opposed  to  high  rates  of  interest 
because  they  increase  its  charges  and  seem  to  restrict  legitimate 
expansion.  Thus  in  all  European  countries,  rates  of  discount 
charged  by  the  banks  have  been  below  the  level  dictated  by  the 
paucity  of  actual  capital  (goods,  not  paper  money). 

Furthermore,  higher  discount  rates  in  the  absence  of  the  gold 
standard   do   not   curtail   loans  as   effectively   and   directly   as 

('")  See  Charts  Nos.  12  and  16,  pages  56  and  74. 


28  The  Foreign  Exchange  Problem 

formerly :  first,  because  a  rising  discount  rate  no  longer  attracts 
gold  or  credit  from  abroad;  second,  because  interest  rates  have 
become  a  much  smaller  item  in  the  cost  of  production,  so  that 
a  higher  rate  of  interest  does  not  weed  out  the  unessential  bor- 
rower. 

The  money  market  is  governed — ^just  like  any  other  market — 
by  the  law  of  supply  and  demand,  and  if  the  latter  exceeds  by 
far  the  former,  the  need  for  restriction  through  the  screw  pro- 
vided by  the  rate  of  interest  makes  itself  felt.  A  discount  rate 
below  the  natural  level  which  corresponds  to  the  supply  and 
demand  of  capital  goods,  favors  the  artificial  creation  of  credit. 

Effect  of  Inflation  on  Income 

To  the  amount  of  money  normally  circulating  in  a  com- 
munity is  added  as  a  result  of  inflation  a  much  larger  amount 
(without  a  corresponding  increase  in  the  volume  of  actual 
goods).  This  new  supply  of  money  will  circulate  at  a  par  with 
the  currency  already  in  existence.  Prices  in  general  will  rise 
against  all  individuals  in  the  community.  However,  those  who, 
for  goods  delivered  or  services  rendered,  have  received  a  larger 
proportion  of  new  currency,  will  be  placed  in  a  more  favor- 
able position  than  those  whose  pre-inflation  income  (capitalists 
living  on  their  interest,  dividends,  or  insurance  moneys ;  pubHc 
ofiicials,  whose  salaries  are  more  or  less  stable),  has  not  been 
increased,  or  only  insufficiently. 

Effect  of  Inflation  on  Bond  Values 

Let  us  take  the  specific  case  of  a  bondholder.  While  with  in- 
flation almost  all  commodities  rise  in  price,  the  market  level  of 
bonds  is  hardly  aff^ected,  except  to  the  extent  that  it  may 
oblige  small  holders  to  part  with  past  savings.  The  investor's 
one  thousand  franc  bond  is  not  converted  into  a  two  thousand 
franc  bond  when  prices  have  risen  one  hundred  per  cent,  but 
remains  a  one  thousand  franc  bond,  the  purchasing  power  of 
which  may  have  been  halved.  He  has  to  contribute  his  share  to 
the  increased  charges  of  the  community  of  which  he  forms  a 
part ;  other  components  of  the  community,  through  the  general 


Factors  which  have  Lowered  the  Foreign  Exchange  Quotations  29 

effect  of  inflation  on  their  income,  may  be  in  a  position  to  bear 
these  higher  expenditures  without  direct  personal  sacrifice.  The 
bondholder,  to  the  extent  that  his  income  is  derived  from  the 
interest  on  his  holdings,  wiU  have  to  carry  without  adequate 
material  compensation  his  full  part  of  the  burdens  of  inflation 
except  in  so  far  as  such  inequality  is  corrected  by  income  and 
excess  profits  taxes  on  a  sliding  scale. 


Ultimate  Effects  of  Inflation 

Like  the  bondholder,  all  classes  with  a  stationary  income  will 
be  compelled  by  the  reduced  purchasing  power  of  their  revenues 
either  to  save  less  or  to  reduce  their  standard  of  living ;  on  the 
other  hand,  those  who  have  profited  by  the  increased  amount  of 
currency  have  an  excess  of  purchasing  power  which  they  may 
or  may  not  use  for  investments  making  for  increased  production. 
The  result  is  that,  in  many  instances,  certain  commodities  which 
are  really  needed  are  not  produced  in  sufficient  quantities,  while 
others  which  are  unessential  are  sometimes  produced  in  large 
volume.  An  abnormal  relation  of  production  to  consumption  is 
created. 

Inflation,  if  unduly  prolonged  or  if  not  counteracted  with 
sufficient  persistence  and  energy,  will  lead  ultimately  with  in- 
creasing acceleration  to  economic  disintegration.  The  continu- 
ally widening  gap  between  production  and  consumption  creates 
difficulties  which  may  become  a  cause  of  hardship  and  often  of 
civic  unrest. 

If  the  temptation  to  work  the  printing  presses  instead  of  the 
factories  is  not  checked  efficiently,  the  quantity  of  goods  avail- 
able for  exchange  into  paper  money  will  become  more  and  more 
scarce;  the  manufacturers  to  part  with  their  valuable  products 
will  require  ever  greater  quantities  of  it,  and  finally  may  decline 
to  receive  it.  This  was  the  case  in  our  own  country  after  the 
Revolutionary  War  when  the  barber  shops  were  wall-papered 
with  useless  continental  notes  and  whence  originated  the  expres- 
sion "not  worth  a  continental." 

Such  a  condition  in  its  most  acute  form  paralyzes,  tem- 
porarily at  least,  all  business  and  credit  transactions,  until  the 


80  The  Foreign  Exchange  Problem 

value  of  the  existing  currency  is  stabilized  or  until  another  cur- 
rency is  established  and  has  gained  the  confidence  of  the  produc- 
ing classes  of  the  community. 

As  regards  the  effect  of  inflation  on  the  foreign  exchanges 
of  paper  standard  countries,  it  can  best  be  illustrated  by  some 
hypothetical  examples:  (1)  If  country  A  inflates  and  country 
B  inflates  at  the  same  rate,  the  exchange  between  them  will  re- 
main numerically  stationary,  all  other  conditions  being  equal; 
(2)  If  country  A  inflates  more  than  country  B,  or  if  country  B 
deflates  while  country  A's  currency  remains  unchanged,  or  is 
inflated,  the  exchange  of  country  B  will  rise  in  country  A;  (3) 
If  country  B  inflates  more  than  country  A,  etc.,  the  contrary 
exchange  movements  will  take  place;  (4)  If  country  A  inflates 
to  a  greater  extent  than  country  B,  A's  exchange  in  country  C 
will  be  quoted  at  a  higher  discount  than  that  of  country  B. 
In  other  words,  the  foreign  exchange  of  country  A  is  nothing 
but  the  comparison  of  the  domestic  purchasing  power  value  of 
its  currency  with  that  of  the  currencies  of  countries  B  and  C. 
But,  at  the  same  time,  it  must  be  borne  in  mind  that  the  exchange 
value  of  country  A  as  quoted  in  countries  B  and  C  may  tem- 
porarily be  raised  or  lowered  through  conditions  or  circum- 
stances which  concern  only  countries  B  and  C  (e.  g.,  danger  of 
revolution  in,  or  war  between  countries  B  and  C  or  D  causing 
heavy  purchases  of  bills  payable  in  country  A).  In  other  words, 
fluctuations  may  occur  in  such  contingencies  independently  of 
any  considerations  connected  with  international  price  levels,  and, 
in  fact,  in  apparent  temporary  contradiction  to  the  principles 
laid  down  in  this  chapter. 

Sumimarizing :  Inflation  causes  a  general  rise  in  prices  of 
merchandise.  It  therefore  results  in  a  proportionate  decrease 
of  the  real  value  of  the  currencies,  as  expressed  m  terms  of 
merchandise.  To  the  extent  that  this  decrease  in  value  reflects 
their  reduced  purchasing  power,  no  perma/nent  or  legitimate 
enha/ncement  of  such  currencies  is  possible  unless  the  purchasmg 
power  is  again  raised.  It  can  he  raised  only  by  a  reduction  of 
the  quantity  of  money  in  circulation,  or  by  an  increase  of  goods, 
or  both. 


(Explanation  and  comment  referring  to  Chart  7  next  page.) 


Fluctuations  of  German  Exchange 

Annual  high  and  low  quotations  of  60 


days  sight  rates  (number  of  dollars  for  4  marks). 

Exchange    quotations    in    terms    of 

United  States  paper  currency  (computed  from  the 
gold  premium). 

1861-1864    exchange    quotations    in 

terms  of  gold  (computed  from  the  paper  quota- 
tions). 

1815-1829  Baltimore-Hamburg  marc  banco,  quo- 
tations converted  to  the  present  standard. 

1833-1840  New  York-Hamburg,  marc  banco, 
quotations  converted  to  the  present  standard. 

1858-1871-  New  York-Berlin,  quotations  con- 
verted to  the  present  standard. 

From  1888,  whenever  there  were  no  60  days 
sight  quotations  available,  they  were  computed 
from  sight  or  cable  rates. 

1914  high  quotations,  more  or  less  arbitrary, 
having  been  computed  from  the  cable  rates  (60 
days  sight  rates  for  the  early  days  of  August 
1914,  not  available). 

1917-1919  No  quotations. 


1815-6       Currency  disorders  here  offset  financial 
and  political  situation  in  Europe. 

1837     Crisis  and  crop  failure  in  the  U.  S. 
1861-65     Civil  War. 

1826     Commercial  depression  in  Europe 
especially  in  England. 

1860     Large  excess  of  exports  from  the 

u.  s. 

1866     Crisis  in  England. 

1870-1     Outbreak     of     Franco-Prussian 
War. 

1914     Outbreak  of  the  Great  War. 


[31] 


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[32] 


FLUCTUATIONS  OF   GERMAN   EXCHANGE 

For  explanation  and  comment  on  this  chart  see  previous  page. 


Factors  which  have  Lowered  the  Foreign 
Exchange  Quotations 

(b)  TRADE  DISTURBANCES. 
Relation  of  Exchange  to  Foreign  Trade 

The  fall  of  the  exchanges  being  due  primarily  to  inflation, 
we  have  attempted  to  analyze  the  effects  of  inflation  on  the 
domestic  economy  of  the  countries  suffering  from  this  affliction. 
Let  us  now  proceed  to  examine  the  relation  of  inflation  to  foreign 
trade. 

As  we  have  seen,  inflation  as  it  proceeds  will  cause  successive 
downward  revaluations  of  the  foreign  currencies.  This  descend- 
ing movement,  due  to  the  abnormal  variations  in  the  price  levels 
of  goods,  caused  by  inflation,  is  not  a  smooth,  but  an  oscillating 
one.  (  Fluctuations  are  also  brought  about  by  speculation  in  ex- 
change, the  causes  and  extent  of  which  are  discussed  in  the  fol- 
lowing chapter.) 

If  the  downward  movement  proceeds  smoothly,  and  as  long 
as  during  this  adjustment  the  exchanges  do  not  differ  too 
radically  from  their  actual  purchasing  power  value,  foreign 
trade  is  not  affected  in  very  vital  fashion  by  this  gradual  de- 
parture of  the  currencies  from  their  former  stable  gold  parities. 

After  aU,  the  question  for  the  American  importer  is  only 
whether  he  can  sell  to  a  responsible  buyer,  with  a  reasonable 
profit,  the  goods  which  he  contemplates  buying;  for  the  Ameri- 
can exporter  the  only  important  consideration  is  the  possibility 
of  selling  to  a  buyer  of  good  credit  standing,  with  a  reasonable 
profit,  the  commodities,  the  purchase  of  which  he  is  consider- 
ing. Both  the  importer  and  the  exporter,  before  conclud- 
ing the  trade,  will  establish  the  total  cost  of  the  merchandise 
either  at  this  or  the  other  end,  in  United  States  dollars. 
Into  this  total  cost  enters  the  cost  of  the  merchandise,  the  freight, 
insurance,  interest,  and  exchange.     The  importer  will  make  a 

[88] 


84  The  Foreign  Exchange  Problem 

saving  whenever  there  is  an  "undervaluation"  of  the  foreign 
currency.  The  exporter,  all  other  conditions  being  equal,  may 
have  to  make  allowance  for  such  undervaluation  in  his  calculation, 
by  offering  a  proportionately  larger  quantity  or  better  quality 
of  goods  than  his  foreign  competitor,  whose  exchange  does  not 
command  so  high  a  premium  as  his  own  currency. 

Thus  the  fate  of  many  a  deal  may  hinge  on  the  question  of 
whether  the  saving  made  by  the  importer  or  the  concession 
imposed  on  the  exporter  (either  in  the  price  or  quantity  or  qual- 
ity of  goods)  is  larger  or  smaller;  for  in  the  one  instance  the 
cost  of  a  specific  article  may  be  so  high,  and  in  the  second  in- 
stance, the  proceeds  of  the  sale  of  a  specific  article  may  be  so 
low,  that  the  trade  not  being  profitable,  the  transaction  may  have 
to  be  abandoned,  or  the  order  may  not  be  secured. 

Relation  of  Exchange  to  Particular  Lines  of  Business 

Of  course,  the  effect  of  an  actual  depreciation  of  exchange 
is  not  the  same  in  the  various  countries  and  on  various  products. 
To  illustrate:  The  exporter  of  cotton  to  France  may  have  a 
margin  of  profit  while  the  manufacturer  of  steel  cannot  export 
his  product.  The  explanation  is  that  the  price  of  cotton  in  France 
may  have  risen  sufficiently  to  make  up  for  the  depreciation  of 
the  franc,  while  French  bids  for  steel  have  not  been  raised  to  an 
adequate  extent.  In  such  a  case,  it  might  be  said  that  the  ex- 
change stands  in  the  way  of  business,  because  the  price  of  steel 
rendered  at  a  French  port,  taking  into  account  the  exchange  as 
one  of  the  components  of  the  cost,  will  not  correspond  to  the 
domestic  French  quotations.^® 

Exchange  and  the  American  Importer 

Bearing  in  mind  that  exchange  oscillations  react  differently 
on  different  lines  of  business,  we  may  nevertheless  lay  down 
the  manner  in  which,  as  a  rule,  the  principal  categories  of  mer- 
chants are  affected.  Practically,  the  American  importer  pays 
today  fewer  dollars  for  one  thousand  pounds,  one  thousand 
francs,  or  one  thousand  marks,  than  in  1914,  but  this  apparent 
saving  is  offset  to  a  great  extent  by  the  fact  that,  owing  to  the 
rise  in  prices  of  merchandise,  these  thousand  pounds,  thousand 

(")  See  also  example  page  89. 


Factors  which  have  Lowered  the  Foreign  Exchange  Quotations  35 

francs,  or  thousand  marks  buy  today  a  much  smaller  quantity 
of  goods.  On  the  other  hand,  if  he  invests  the  same  amount  of 
dollars,  namely,  $4,866.50,  $192.94,  and  $238.18,  he  receives 
a  much  larger  quantity  of  pounds,  francs,  and  marks;  viz., 
£1247 :16 :4,  fcs.  2,572.53,  mks.  14,010.59."  If  there  is  real  de- 
preciation, in  spite  of  the  rise  in  prices  which  has  taken  place  in 
the  meantime  in  Europe,  these  £1247:16:4,  fcs.  2,572.53,  or 
mks.  14,010.59,  converted  into  merchandise  in  the  respective 
countries  will  generally  yield  him  more  goods,  in  quantity  or  in 
quality,  than  he  would  have  received  in  merchandise  before  the 
war  for  his  £1,000,  fcs.  1,000,  or  mks.  1,000. 

Exchange  and  the  American  Exporter 

The  American  exporter,  who  prior  to  the  war  obtained  for 
merchandise  invoiced  at  $1,000  respectively,  £205:9:9,  or  fcs. 
5,183.16  or  mks,  4,198.50,'"  now  receives  for  a  bill  of  goods  in- 
voiced at  $1,000,  £256:8:3,  or  fcs.  13,333.33,  or  mks.  58,- 
823.53;^^  but  in  view  of  the  rising  prices  in  terms  of  paper 
money  in  Europe,  this  large  quantity  of  European  currency 
may  not  secure  as  great  a  quantity  of  merchandise  as  the  cor- 
responding $1,000  would  buy  of  merchandise  in  the  United 
States.  The  American  exporter  will  always  quote  his  European 
customer  a  price  in  European  paper  money  which,  if  reconverted 
into  goods,  will  reimburse  him  with  a  reasonable  profit  for  the 
$1,000  he  invested.  This  American  export  price  will  in  many 
cases  be  higher  than  the  foreign  importer^^  would  have  to  pay 
elsewhere,  because  the  exorbitant  premium  on  the  American 
dollar  abroad  will  generally  absorb  all,  if  not  more  than,  the 
difference  between  the  prices  of  certain  goods  in  the  United 
States  (gold  prices)  and  the  prices  of  the  same  goods  abroad 
(paper  prices  converted  into  gold  at  the  prevailing  rate  of  ex- 
change). 

(")  Calculated  at  the  approximate  rates  quoted  in  New  York  on  Febru- 
ary 16th;  viz.,  $3.90  per  pound,  7.50  cents  per  franc,  1.70  cents  per  mark. 
We  have  chosen  for  purposes  of  illustration  the  pound,  the  franc,  and  the 
mark,  as  being  typically  representative  of  the  varying  degrees  of  deprecia- 
tion now  prevalent  in  the  exchange  markets. 

(*•)  Calculated  at  the  gold  pars  of  $4.8665  per  pound,  19.294  cents  per 
franc,  and  28.818  cents  per  mark. 

(^)  This  remark  has  also  an  important  bearing  on  our  South  American 
trade. 


36  The  Foreign  Exchange  Problem 

Exchange  and  the  European  Importer 

Conversely,  the  European  importer*^  irrespective  of  the 
possible  general  rise  of  merchandise  prices  in  the  United  States, 
has  to  pay  a  much  larger  amount  of  his  own  currency  because  of 
its  reduced  purchasing  power  and  the  possible  additional  under- 
valuation for  goods  bought  in  the  United  States;  namely, 
£256:8:3  for  $1,000,  fcs.  13,333.33  for  $1,000,  mks.  58,823.53 
for  $1,000;  if  he  spent  only  the  same  amount  of  his  own  cur- 
rency as  before  the  war;  namely,  £205:9:9,  fcs.  5,183.16,  or 
mks.  4,198.50,  he  would  receive  a  much  smaller  quantity  of  mer- 
chandise. 

Exchange  and  the  European  Exporter 

The  European  exporter  before  the  war  obtained  for  £1,000, 
fcs.  1,000,  or  mks.  1,000  of  merchandise,  respectively,  $4,866.50, 
$192.94,  and  $238.18.  Now  the  European  exporter  can  buy  in 
the  United  States  with  the  proceeds  of  certain  goods  which  in 
England,  France,  and  Germany  would  sell  with  a  normal  trading 
profit,  respectively,  at  £1,000,  fcs.  1,000,  and  mks.  1,000,  other 
goods  which  if  sold  at  home  will  yield  him  a  sum  in  dollars  which 
will  be  greater  or  smaller  than  these  amounts  (e.  g.,  $3,900, 
$75,  and  $17^^)  according  as  pounds,  francs,  or  marks  are 
quoted  here  below  or  above  their  actual  purchasing  power  value. 
The  profit  resulting  from  any  undervaluation  is  lost  if  the 
European  exporter,  rather  than  convert  his  dollars  into  a  check 
or  cable  transfer  for  pounds,  francs,  or  marks,  uses  the  yield  in 
dollars  to  buy  actual  goods  in  America;  for,  if  there  is  under- 
valuation of  foreign  currency  in  the  United  States,  this  means 
that  the  same  quantity  of  the  same  goods  in  the  United  States 
cost  more  than  it  would  cost  abroad,  all  other  conditions  being 
equal. 

The  most  serious  difficulties  encountered  by  traders  in  the 
pursuit  of  their  foreign  business  are:   First,  the  violent  fluctu- 

(")  Although  in  this  study  we  have  more  especially  considered  the 
conditions  in  European  nations,  yet  our  remarks  apply,  in  general,  with 
equal  force  to  our  trade  with  all  other  countries  where  the  dollar  is  quoted 
at  a  premium. 


Factors  which  have  Lowered  the  Foreign  Exchange  Quotations  37 

ations  of  the  exchanges  which  render  commerce  more  hazardous 
both  as  regards  profits  and  risk ;  and  second,  any  real  deprecia- 
tion beyond  the  purchasing  power  value. 


Exchange  Fluctuations  and  Future  Merchandise  Contracts 

Of  the  two  obstacles,  the  constant  wide  upward  and  down- 
ward swings  (due  to  causes  which  have  been  commented  upon 
elsewhere*^ )  are  especially  detrimental  where  transactions  involve 
future  delivery.  In  some  cases,  when  normal  methods  of  com- 
pensation fail,  barter  facilitates  the  exchange  of  goods ;  however, 
to  carry  on  international  business  on  its  present  scale  is  hardly 
possible  on  this  basis.  To  move  the  enormous  quantities  of  goods 
which  make  up  the  world's  trade,  there  is  necessary,  not  only 
money,  but  also  and  chiefly,  credit.  It  is  difficult  to  finance  ap- 
preciable quantities  of  goods  on  credit  until  the  purchase  or  sale 
price  can  be  established  exactly,  or  with  a  fair  degree  of  certain- 
ty ;  i.  e.,  until  the  value  in  the  importer's  or  exporter's  own  cur- 
rency is  definitely  fixed,  by  means  of  future  contracts  of  ex- 
change. If  the  date  of  settlement  is  postponed,  either  the  buyer 
or  the  seller,  or  an  intermediary,  must  bear  the  exchange  risk. 
This  hazard  cannot  be  completely  eliminated  by  the  clearance 
of  spot  transactions  in  view  of  the  interval  which  must  elapse  be- 
tween the  date  of  conclusion  of  the  trade,  and  the  date  of  the 
shipment  or  of  the  payment  of  the  cost,  or  the  collection  of 
the  proceeds  of  the  sale.  The  importer  will  want  to  protect 
himself  against  a  rise  in  foreign  exchange,  and  the  exporter  will 
desire  to  protect  himself  against  a  fall.  Someone  has  to  assume 
the  role  of  guaranteeing  either  of  the  interested  parties  against 
these  contingencies.  The  speculator,  as  time  went  on,  was  less 
and  less  anxious  to  assume  this  role.  The  local  banks,  in  like 
manner,  have  been  more  loath,  considering  the  important 
amounts  and  the  greater  risks,  to  underwrite,  as  it  were,  this 
exchange  insurance,  unless  they  were  able,  according  to  good 
practice,  to  cover  themselves  by  means  of  offsetting  contracts 
in  one  of  the  leading  markets.  From  a  practical  standpoint, 
the  American  exporter  has  been  somewhat  favored  in  this  con- 

{*")  See  page  51. 


No.  8 


S     g     ^     ^ 

00        *■        t>~       oc 

Money  in  Circulation 

United  States:  (4)  Total  money  in  circulation  in  $1,000,000;  being  total 
of  paper  and  coin  minus  the  coin  and  paper  held  in  the  Treasury ;  it  includes 
Federal  Reserve  currency  from  1916  on. 

Insert  reduced  to  1/10  of  main  scale. 

France:  (2)  Annual  average  of  the  notes  of  the  Banli  of  France  in  circula- 
tion in  100,000,000  francs.  The  figures  up  to  1807  are  the  annual  average  of 
the  hig'h  and  low  point  of  the  circulation  for  the  year. 

Insert  reduced  to  1/10  of  main  scale. 

Great  Britain  :  (3)  Annual  average  of  total  notes  of  the  Bank  of  England 
held  by  the  public  in  £1,000,000.     Figures  from  1914  on  include  currency  notes. 

Insert  reduced  to  1/10  of  main  scale. 

Germany:  (1)  Circulation  of  the  Reichsbanls  and  other  banlis  (which 
decreased  from  19  to  5  during  the  period)  at  the  end  of  each  year  in  100,000,000 
marlis.  Beginning  with  1914  the  circulation  of  the  War  Loan  Association  Cer- 
tificates has  been  included. 

Insert  reduced  to  1/10  of  main  scale. 

[88] 


Factors  which  have  Lowered  the  Foreign  Exchange  Quotations  39 

nection.  Due  to  a  belief  in  the  ultimate  recovery  of  certain  for- 
eign exchanges,  there  has  been  quoted  here  almost  constantly  a 
more  or  less  heavy  premium  for  these  exchanges  for  forward  de- 
livery (Sterling,  French  and  Belgian  francs  being  the  most 
prominent).*^ 

Exchange  Fluctuations  and  Price  Movements 

Violent  fluctuations  in  the  exchange  rates  may  overthrow 
all  cost  calculations,  either  for  the  buyers  or  the  sellers. 
Let  us  illustrate  this  by  one  concrete  example:  An  inspec- 
tion of  the  movement  of  cotton  prices  respectively  in  New  York, 
Liverpool,  and  Bremen  shows  that  in  September  1920,  cotton 
prices  fell  in  New  York  and  to  a  less  extent  in  Liverpool ;  Bremen 
prices  showed  a  remarkable  rise  in  terms  of  marks.  The  fall  in 
cotton  prices  in  New  York  was  attributable  to  the  prospects  of 
a  better  crop,  to  the  abstention  of  the  buyers,  and  to  the  threat- 
ening prospects  of  an  English  coal  miners'  strike  which,  it  was 
felt,  would  decrease  the  spinners'  demands  for  cotton.  These 
same  factors  also  caused  the  fall  in  Liverpool  cotton  prices ;  New 
York  exchange  on  London  receded  somewhat  in  September, 
which  accounted  for  the  fact  that  Liverpool  cotton  prices  did  not 
decline  so  much  as  New  York  cotton  prices.  On  the  Bremen 
market,  however,  the  above  price  movements  lost  all  their  effect, 
since  the  quotation  of  dollars  in  Germany,  in  terms  of  marks, 
rose  about  25%  in  the  same  month,  thus  raising  considerably 
the  cost  of  American  cotton  to  Bremen  merchants,  although  the 
price  of  cotton  free  on  board  New  York  had  heavily  declined. 
This  demonstrates  how  under  present  conditions  commodity 
prices  fail  to  respond  similarly  to  similar  trade  conditions  the 
world  over. 

Effect  of  Real  Exchange  Depreciation  on  Foreign  Trade 

While  it  is  true  that,  as  a  rule,  low  exchanges  per  se  are  not 
a  hindrance,  a  truly  adverse  exchange  tends  to  restrict  interna- 

(")  A  clearing  house  for  dealing  in  foreign  exchange  futures  has  been 
established  at  Antwerp  as  a  means  of  protecting  Belgian  purchasers  of 
foreign  goods  against  exchange  fluctuations. 


40  The  Foreign  Exchange  Problem 

tional  commerce.  When  the  foreign  exchanges  are  quoted  helow 
their  purchasing  power,  the  importation  of  goods  by  the  debtor 
countries  having  debased  currencies  is  discouraged  and  the  ex- 
port trade  of  those  countries  which  enjoy  the  doubtful  privilege 
of  having  their  currency  quoted  at  prohibitive  premiums  is  en- 
dangered. Unless  precautionary  measures  are  taken,  the  in- 
ternal economy  of  the  creditor  countries  may  more  or  less  ser- 
iously suffer  from  the  increasing  flow  of  alien  products  attracted 
by  the  export  premium  granted,  as  it  were,  to  the  foreign  ex- 
porter. Isolating  for  the  moment  two  countries:  When  France 
imports  more  from  the  United  States  than  France  exports  to  the 
United  States  in  goods  or  in  services,  and  the  deficit  is  not  made 
up  by  a  credit  extension  from  the  United  States  to  France,  and 
exchange  is  not  automatically  restored  by  gold  movements,  ex- 
change must  depreciate  at  least  temporarily  below  the  purchasing 
power  value.  This  decline  will  immediately  make  it  profitable 
for  France  to  send  to  the  United  States  certain  goods  which  she 
could  not  ship  while  the  exchanges  had  their  former  purchasing 
power.  At  the  same  time,  and  for  converse  reasons,  it  would 
become  unprofitable  for  the  United  States  to  forward  certain 
goods  to  France.  Exports  from  the  United  States  will  neces- 
sarily be  impeded  when  the  franc  is  quoted  here  lower  than  would 
correspond  to  the  general  level  of  merchandise  prices  prevailing 
in  France  as  compared  with  that  of  the  United  States.  Whea 
France  buys  goods  from  the  United  States,  in  addition  to  pay- 
ing higher  prices  (as  compared  to  pre-war  levels),  she  must  pay 
the  freight,  insurance,  interest,  and  the  premium  on  the  dollar. 
Therefore,  the  more  the  foreign  exchanges  decline  below  their 
purchasing  power;  i.  e.,  as  the  undervaluation  grows,  the  more 
goods  will  be  eliminated  from  the  list  of  materials  or  articles 
which  can  be  imported  by  the  debtor  country. 

Those  commodities  or  products  which  are  most  needed — food- 
stufi^s,  clothing,  and  coal — foreign  consumers  will  attempt  to 
import  at  whatever  cost,  and  however  low  their  exchange  may 
drop.  As  far  as  other  commodities  or  products  are  concerned, 
they  may  be  exportable  or  importable  to  a  greater  or  lesser 
extent,  not  because  of  numerically  low  exchange  rates,  but  be- 
cause the  inflation  policy  in  one  or  both  of  the  countries  con- 


Factors  which  have  Lowered  the  Foreign  Exchange  Quotations  41 

cemed  has  brought  it  about  that  a  greater  or  smaller  quantity 
of  such  particular  commodities  has  been  produced  or  consumed 
than  would  otherwise  have  been  the  case.  The  goods  that  arc 
really  needed  are  often  not  imported  in  adequate  quantities,  be- 
cause their  prices  are  not  high  enough  to  attract  imports  from 
abroad.  The  demand  of  the  people  who  need  these  commodities 
is  not  effective  because  they  cannot  pay  in  gold  or  goods  for  their 
purchases.  On  the  other  hand,  certain  individuals  who  control 
sufficient  purchasing  power  may  use  it,  in  the  absence  of  legal 
restrictions,  to  import  luxuries  rather  than  essential  goods. 
Therefore,  the  decline  of  the  foreign  exchanges  will  not  neces- 
sarily eliminate,  in  the  order  of  their  usefulness,  the  various  com- 
modities and  products  from  the  list  of  importable  articles. 

With  the  growing  decline  in  exchange  caused  by  the  adverse 
trade  balance,  more  and  more  commodities  have  become  export- 
able from  Europe.  As  a  result,  some  European  governments, 
viewing  with  alarm  the  increasing  size  of  the  stream  of  goods, 
which,  although  urgently  needed  at  home,  flowed  out  of  their 
countries,  have  limited  their  exportation  by  various  devices. 
They  have  imposed  embargoes,  adopted  licensing  systems,  or 
rationed  the  volume  of  exports. 

All  these  measures  on  the  part  of  countries  with  unfavorable 
balances  of  indebtedness  will  cause  their  exchanges  to  depreciate 
even  beyond  their  purchasing  power  value.  What  is  the  value 
of  a  draft  for  a  thousand  Austrian  crowns  if  one  cannot  convert 
it  into  gold  and  if  one  is  not  allowed  to  export  one  thousand 
Austrian  crowns'  worth  of  goods.? 


Effect  of  Export  Embargoes 

Since  there  are  not  enough  individuals  who  are  willing  to  pur- 
chase such  drafts  as  an  investment  or  speculation  (or,  in  other 
words,  who  would  agree  to  delay  exercising  their  option  to  buy 
merchandise  in  Austria  with  the  equivalent  of  the  draft,  because 
they  hope  that  such  merchandise  will  fall  in  price,  and  exchange 
rise),  the  Austrian  exchange  is  bound  to  depreciate  from  the  ac- 
tual purchasing  power  value  in  a  degree  determined  by  the 
severity  of  the  regulations,  and  the  size  of  the  investment  and 


42  The  Foreign  Exchange  Problem 

speculative  market  for  crowns.  Such  measures  prevent  the  for- 
eign potential  buyers  from  exercising  their  rights  on  an  equal 
basis  with  the  individuals  in  the  particular  country  involved ;  the 
price  levels  cannot  be  evened  up,  inasmuch  as  the  tendency  for 
the  foreign  merchants  to  take  advantage  of  the  greater  purchas- 
ing power  cannot  exert  itself.  Regulations  of  this  nature  re- 
sult in  a  restriction  of  imports  from,  or  a  curtailment  of  ex- 
ports to  foreign  countries.  They  are  an  impediment  to  the 
normal  adjustment  of  the  exchanges  and  they  leave  the  market 
of  that  particular  exchange  exposed  to  all  the  dangers  inherent 
in  the  dealings  in  the  common  stock  of  an  enterprise  which  is  in 
a  difficult  financial  condition  and  whose  ultimate  power  to  re- 
deem its  promises  is  valued  at  a  small  fraction  of  the  nominal 
value  of  the  stock.  Superficial  observers  are  likely  to  draw 
wrong  conclusions  from  the  fact  that  some  exchanges  register 
apparently  a  very  great  impairment  of  the  purchasing  power  of 
certain  countries.  Some  nations  might  take  advantage  of  such 
devices  to  veil  their  actual  productive  capacity  and  restrict  their 
export  activities  temporarily,  while  at  the  same  time  accepting 
orders  and  accumulating  stocks  for  the  future. 

Effect  of  Special  Export  Prices  to  Foreigners 

Similarly  a  permanent  depreciation  of  exchange  is  produced 
by  the  practice  of  raising  prices  on  certain  or  all  goods  for  ex- 
port, to  some  multiple  of  the  internal  price.  Inasmuch  as  a 
foreign  draft  will  yield  only  the  equivalent  of  the  purchasing 
power  which  it  commands,  if  all  the  exportable  commodities 
bought  for  export  are  priced  at  ten  times  the  internal  price,  it 
is  evident  that  the  draft  is  worth  ten  times  less  than  if  the  pro- 
ceeds of  it  might  be  used  to  buy  the  same  commodities  at  the 
internal  price.  The  effect  upon  international  trade  of  the  extra 
high  prices  charged  foreigners  is  the  same  as  that  of  an  export 
tariff. 

All  these  measures — the  imposition  of  export  embargoes  or 
the  practice  of  charging  higher  prices  to  foreigners — ^by  what- 
ever motive  they  may  have  been  dictated,  retard  the  ultimate 
equilibrium  of  the  exchanges  and  introduce  factors  of  insta- 
bility into  markets  which  already  have  to  contend  with  numerous 


Factors  which  have  Lowered  the  Foreign  Exchange  Quotations  43 

other  uncertain  elements.  The  period  of  adjustment — for  ad- 
justment must  ultimately  come — ^is  prolonged,  and  the  question 
is  whether  the  ephemeral  advantages  to  be  derived  from  such 
restrictions  outweigh  the  disadvantages  which  are  felt  for  a 
much  more  protracted  period. 

The  logical  way  to  meet  the  effects  of  extra  high  prices  to 
foreigners,  and  export  restrictions,  such  as  we  have  described, 
would  be  to  eliminate  the  cause.  It  has  been  argued  that  to 
abolish  them  would  mean  that  some  countries  would  be  depleted 
of  goods.  However,  the  heavy  purchases  for  foreign  account 
would  fer  se  raise  prices  to  such  an  extent  that  ultimately  further 
exports  would  be  rendered  impossible.  It  must  not  be  forgotten 
that  in  the  last  analysis,  these  barriers,  in  the  form  of  embargoes, 
have  been  erected  to  prevent  goods  from  leaving  countries  which 
are  already  indebted,  and  flowing  to  those  who  are  anxious  to 
obtain  these  goods  in  payment  of  balances  due  them.  For,  after 
all,  depreciated  exchanges  mean  that  the  foreign  importers  have 
been  buying  more  than  they  can  pay  for.  They  are  the  inevit- 
able outcome  of  the  operation  of  an  economic  law.  An  attempt 
to  counteract  it  by  legislation  or  any  other  device,  is  bound  to 
have  detrimental  results. 

Effect  of  Reduction  of  Foreign  Credits  on  U,  S.  Exports 

The  practice  of  charging  higher  prices  to  foreigners  and  the 
imposition  of  export  embargoes  are  responsible  for  a  certain 
share  of  the  real  exchange  depreciation.  The  balance  (which 
probably  forms  the  major  part)  is  attributable  to  the  temporary 
slackening  in  the  extension  of  short  or  long  term  credits,  which 
in  many  cases  acts  as  a  deterrent  to  the  shipment  of  goods  to 
those  markets  to  which  higher  prices  would  normally  attract 
them. 

On  this  score  some  criticism  has  been  directed  against  finan- 
cial institutions  in  general,  based  on  an  alleged  lack  of  co-opera- 
tion in  matters  of  credit  for  foreign  trade.  It  should  be  remem- 
bered in  this  connection  that  the  commercial  banks  as  at  present 
organized  are  obliged  to  invest  the  greater  part  of  their  available 
funds  in  the  most  liquid  and  marketable  form.  The  bankers 
are  anxious  to  harmonize   the  protection  of  the  interests   of 


44  The  Foreign  Exchange  Problem 

the  depositor,  which  for  them  must  admittedly  be  the  para- 
mount consideration,  with  the  desire  to  assist  and  further  that 
most  important  branch  of  our  internal  economy  which,  in  finding 
foreign  outlets  for  our  surplus  production,  creates  more  work  and 
wealth  at  home.  The  rapid  development  of  both  our  export  and 
import  trade  during  the  last  decade,  the  rise  in  prices — involving 
much  more  strenuous  financial  efforts, — ^and  the  abnormal  credit 
conditions  prevailing  abroad — claiming  much  more  extended  ad- 
vances and  discount  privileges — have  all  rendered  this  task  more 
difficult.  It  is  to  be  hoped  that  ways  and  means  will  be  found 
to  satisfy,  in  an  ever  greater  measure,  the  legitimate  demands 
for  funds  to  be  allocated  to  foreign  trade.  Allowance  should, 
however,  always  be  made  for  the  fact  that,  whereas  in- 
dividuals are  at  liberty  to,  and  will  immobilize  their  savings  for 
more  or  less  long  periods,  provided  the  remuneration  is  adequate, 
the  principles  which  have  guided  cautious  bankers  at  all  times 
in  the  investment  of  their  deposits  (which  are  only  in  part 
actual  savings)  cannot  be  infringed  upon  for  any  extended  time 
without  running  counter  to  the  interests  of  the  community  as  a 
whole.  Our  banks  may  be  relied  upon  to  follow  a  middle 
course  which  will  satisfy  both  their  duty  toward  the  depositors 
and  their  natural  predisposition  in  favor  of  foreign  trade. 

Excluding  the  undervaluation*^  attributable  to  the  trade  re- 
strictions mentioned  above,  the  present  depreciation  of  the  ex- 
changes cannot  be  corrected  until  exports  from  Europe  come 
forth  in  sufficient  volume  or  until  the  debased  exchanges  again 
attract  American  capital  so  as  either  to  shorten  supplies  and 
thereby  raise  merchandise  prices  here,  or  to  lower  merchandise 
prices  in  Europe  by  increasing  her  supply  of  goods.  At  this  time 
price  levels  are  not  raised  here  or  lowered  in  Europe  and  exchange 
rates  do  not  represent  equal  purchasing  power  in  the  respective 
countries.  The  pressure  which  should  bring  exchange  back  from 
real  depreciation  to  the  purchasing  power  value;  viz.,  a  move- 
ment of  capital  or  goods  from  the  United  States  to  Europe,  does 
not  act  with  sufficient  intensity  because  there  is  not  sufficient 
capital  invested  or  credit  extended  for  the  time  being. 

(*•)  The  result  of  an  attempt  to  establish  to  what  extent  the  pound 
sterling,  franc,  and  mark  are  undervalued,  may  be  found  on  pages  122-124. 


Factors  which  have  Lowered  the  Foreign  Exchange  Quotations  45 

As  a  practical  illustration:  Imports  to  Italy  are  hampered 
by  the  real  exchange  depreciation  against  her;  on  the  other 
hand,  the  normal  corrective — more  exports  from  Italy — is  in- 
operative since  she  must  import  certain  commodities  before  she 
can  export.  Importations  into  France  are  similarly  affected, 
though  probably  not  to  the  same  extent. 

Great  Britain's  Balance  of  Indebtedness 

Great  Britain  is  placed  at  the  same  disadvantage  as  the 
United  States  in  certain  markets  of  the  world.  Her  exchange 
in  many  centers  is  at  a  premium  just  as  the  dollar,  which,  to 
a  certain  extent,  handicaps  her  in  trading  with  such  countries. 
Actual  exchange  depreciation,  while  in  force,  acts  like  a  protec- 
tive tariff  enacted  by  an  importing  country;  actual  apprecia- 
tion of  exchange  resembles,  in  its  effects  at  least,  a  penalty  in- 
flicted on  the  commerce  of  an  exporting  country.  Europe's  ex- 
changes in  general  would  probably  show  still  greater  deprecia- 
tion in  the  United  States  (and  sterling  exchange  would  be  cor- 
respondingly higher,  or  what  is  more  likely,  Lombard  Street^* 
would  have  borrowed  less  from  us),  if  in  addition  to  the  credits 
opened  by  us,  British  banks  and  manufacturers  had  not 
also  gi'anted  credits  to  Europe*^  over  and  above  those  which 
we  had  opened  ourselves.  To  do  this.  Great  Britain  bor- 
rowed in  turn  from  us  on  her  own  guarantee;  in  other  words, 
although  she  is  now  exporting  to  the  United  States  to  almost 
the  same  extent  that  she  is  importing  from  us,*^  she  has  not  been 
able  to  set  aside  any  surplus  to  cancel  her  past  indebtedness. 
She  has  been  exporting  to  Europe  rather  than  to  the  United 
States.  British  depositors  and  British  investors,  because  of 
their  closer  geographical  location,  and  also,  undoubtedly,  by 
reason  of  their  longer  association  with,  and  their  more  intimate 
knowledge  of  Continental  business  and  affairs,  underwrite  the 
risks  which  American  manufacturers,  exporters,  investors,  and 
banks  do  not  yet  care  to  assume  to  the  fullest  extent;  British 

(**)  The  London  center  for  British  finance. 

(*")  That  is,  exported  goods  to  Europe  directly,  or  through  others. 

(*•)  This  does  not  imply  that  trade  has  reached  its  pre-war  volume. 
As  a  matter  of  fact,  measured  in  volume  of  goods,  our  trade  with  England 
is  far  behind  pre-war  figures. 


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Bank  Deposits 

Bank  of  France:  (1)  Average  annual  balance  of  current  accounts  (ex- 
clusive of  treasury  deposits)    in  10,000,000  francs. 

Insert  reduced  to  1/8  of  main  scale.  

Bank  of  England:  (3)  Annual  average  of  total  deposits  In  £1,000,000  up 
to  1900 ;  1901  on  annual  average  of  quarterly  averages  of  total  deposits  (ex- 
clusive of  capital,  rest,  and  post  bills). 

Insert  reduced  to  1/8  of  main  scale. 

Reichsbank:  (2)  Open  deposits  at  the  end  of  every  year  In  100,000,000 
marks. 

Dec.  31,  1920— Mks.  22,327,144,000. 

Insert  reduced  to  1/8  of  main  scale. 

[46] 


Factors  which  have  Lowered  the  Foreign  Exchange  Quotations  47 

trade  is,  of  course,  directly  benefited — as  it  has  always  been  in 
the  course  of  history — by  this  more  aggressive  policy. 

It  is  apparent  that  any  naiion,  to  make  its  foreign  trade 
count  in  its  annual  international  settlement,  must  export  either 
to  markets  which  are  in  a  position  to  adjust  their  debit  balances 
in  gold  or  goods,  i.  e.,  where  she  can  buy  drafts  which  will  be 
equivalent  to  gold,  or  to  countries  where  she  has  debts  to  liqui- 
date.*^ While  Great  Britain  is  thus  a  debtor  in  relation  to  the 
United  States,  she  is  a  creditor  of  Europe  at  the  same  time. 
But  as  far  as  her  balance  of  payments  with  our  country  is  con- 
cerned, this  fact  has  no  bearing  for  the  moment.  Normally,  with 
the  whole  world  on  the  gold  standard,  Great  Britain  would  use 
these  credits  to  liquidate  her  floating  debts  and  interest  charges 
to  the  United  States.  Today  her  debtors  are  unable  to,  or  do 
not  pay  and  thus  do  not  help  her  to  meet  her  adverse  balance 
of  payments.*^ 

Effect  of  Trade  Disturbances  on  the  Economy  of  the  United 
States 

The  reduction  of  the  volume  of  our  exports  to  any  consider- 
able degree  (unless  more  credit  is  ultimately  extended)  will  di- 
minish the  value  of  the  tremendous  productive  machinery  built  up 
in  our  country  since  1914.  Stimulated  by  the  war,  our  domestic 
production  has  been  expanded  in  certain  lines  for  Europe's 
specific  needs.  This  output,  thrown  back  upon  the  United 
States,  is  beyond  the  present  demands  of  our  people,  mostly  be- 
cause the  production  of  the  rest  of  our  commodities  has  not  been 
increased  at  the  same  ratio.  We  are  desirous  of  exchanging  the 
goods  produced  in  excess  for  other  merchandise  which  is  of  more 
value  to  us.  We  cannot  dispose  of  them  or  use  that  particular 
industrial  capacity  except  by  foreign  trade.    The  decline  of  ex- 

(*^)  Unfortunately  for  us,  even  those  countries  which  are  supposed  to  be 
able  to  settle  find  it  advantageous  in  many  instances  to  delay  payments  be- 
cause of  the  extraordinary  premium  on  the  dollar  (e.  g.,  South  America). 

(**)  The  excess  of  Great  Britain's  imports  over  her  exports  during  the 
year  1920  amounted  to  £878,767,136  over  against  which  she  had  invisible 
exports  which  have  been  estimated  as  high  as  £640,000,000.  There  was, 
therefore,  in  her  favor,  theoretically  at  least,  a  balance  amounting  to  over 
£200,000,000.  However,  the  invisible  exports  are  to  a  large  extent  made 
up  of  interest  income  from  the  financially  weaker  Allies  which  has  not  been 
paid. 


48  The  Foreign  Exchange  Problem 

ports  is  increasing  the  available  stocks  and  is  contributing  to  the 
fall  in  prices,  which  has  been  proceeding  since  approximately 
the  middle  of  1920.  Our  industries  have  now  begun  to  reduce 
their  extensive  production  for  foreign  markets  and  to  adapt  their 
output,  in  the  main,  more  closely  to  the  domestic  demands.  In 
case  credits  on  a  large  scale  should  be  granted  hereafter,  it  would 
have  to  be  considered  whether  it  would  be  wise  to  adjust  pro- 
duction and  consumption  once  more,  with  a  view  of  providing 
for  a  larger  exportation  of  goods  which  may  or  may  not  be 
permanent.  We  are  just  emerging  from  a  period  of  deflation. 
True,  the  speculative  element,  encouraged  by  a  certain  amount  of 
inflation,  had  also  driven  domestic  prices  up  beyond  their  normal 
level;  however,  we  must  bear  in  mind  that  a  reduction  in  the 
volume  of  foreign  purchases  and  an  accumulation  of  commodities 
will  at  all  times  mean  a  loss  not  only  for  the  exporter,  but  also 
for  the  farmer  of  the  Middle  West,  the  cotton  planter  of  the 
South,  and  the  nation  as  a  whole. 


{Explanation  and  comment  referring  to  Chart  10  next  page.) 

Index  Numbers  of  Prices 

Index  numbers  of  wholesale  prices  on  a  com- 
parable basis,  average  1901-1910  equals  100. 

United  States:  (4)  dotted  line  gives  prices  df 
commodities  in  terms  of  gold,  1862-1879. 

France:  (1) 

Great  Britain:  (2)  dotted  line  gives  prices  of 
commodities  in  terms  of  gold,  1801-1820. 

Germany:  (3)  No  figures  1914-1919;  1920 
figure=l  635. 

INDEX  NUMBERS  OF  PRICES 
Except  for  disturbances  caused  by  war  or  dis- 
ordered currency  conditions,  prices  in  the  differ- 
ent countries  fluctuate  more  or  less  in  unison. 
World  prices  rose,  beginning  with  the  French 
Revolution  and  extending  through  the  Napoleonic 
Wars.  Then  followed  a  fall  extending  to  about 
1850.  From  1850  to  1873  prices  rose,  and  then 
declined  continuously  till  1896.  From  1896  to  the 
beginning  of  the  great  war,  there  was  another 
general,  gradual  rise  in  prices.  The  rises  during 
the  present  war,  have,  except  in  the  case  of  the 
United  States,  been  greater  than  at  any  time 
during  the  history  of  the  past  one  hundred  and 
thirty  years.  The  Bank  of  England  suspended 
specie  payments  in  1797  and  did  not  fully  resume 
until  1821.  Currency  in  the  United  States  was  on 
a  paper  basis,  in  certain  parts  of  this  country  from 
1814-17  and  all  over  the  United  States  from 
1861-79. 

1800     Crisis  in  England. 
1810     Crisis  in  England. 
1812     Outbreak  of  the  war  of  1812. 
1814     Crisis  in  the  United  States. 
1816     End  of  Napoleonic  Wars. 
1818     Crisis  in  England. 
1825     Crisis  in  England. 

1836  Crisis  in  England. 

1837  World  Crisis. 
1839     Small  Crisis  in  United  States. 
1847     Crisis   in  England. 

1865  End  of  Civil  War. 

1866  Crisis  in  England. 
1870  Outbreak  of  Franco-Prussian  War. 
1873  World  Crisis. 
1907  World  Crisis. 
1914  Great  War. 

[49] 


No.  10 


,SU 


Slllllil 


so     S9     5 


;p       s      >«      •;^      »vi 

I    §   §   ^  ^ 


INDEX   NUMBERS    OF   PRICES 

For  explanation  and  comment  on  this  chart  see  previous  page. 


[50] 


Factors  which  have  Lowered  the  Foreign 
Exchange  Quotations 

(c.)     SPECULATION. 

Some  of  the  exchange  fluctuations  have  been  accounted  for 
by  the  rapid  changes  in  the  relative  prices  of  merchandise  due  to 
currency  disorders.  But  the  paramount  cause  for  the  violent 
oscillations  of  the  exchange  rates  lies  undoubtedly  in  the  exten- 
sive speculation.  The  outstanding  credits  in  the  form  of  bills 
of  exchange,  deposits  in  European  banks,  open  accounts,  and 
finally  in  European  currency  (held  in  countries  other  than  those 
in  which  they  are  legal  tender)  form  a  constantly  dangerous  and 
incalculable  element  in  the  foreign  exchange  markets.  The  ex- 
portation of  currency  by  European  countries  has  been  especially 
serious.  Considerable  quantities  of  such  monies,  particularly 
francs,  lire,  marks,  Austrian  crowns,  and  rubles,  are  being  held 
by  the  former  neutral  countries  (Switzerland,  Holland,  Spain, 
Sweden,  Norway,  and  Denmark).  Since  the  armistice  citizens 
of  the  former  belligerent  countries  themselves  participated  in 
this  speculation  to  quite  a  considerable  extent.  Either  as  a  re- 
insurance against  apprehended  risks  incurred  in  connection  with 
their  business  transactions  or  the  administration  of  their  fortunes 
("the  flight  of  capital"),  or  simply  as  a  matter  of  speculation, 
they  went  long  or  short  on  foreign  currencies.  Such  operations 
were,  however,  often  restricted  or  forbidden  by  the  laws  of  their 
country.  Quite  frequently  too,  the  proceeds  of  merchandise 
exported  from  one  of  the  European  countries  to  another,  instead 
of  being  repatriated,  were  invested  in  such  other  countries,  thus 
depriving  the  market  of  their  own  exchange  of  the  support 
which  was  so  necessary. 

Incidentally,  it  should  be  noted  that  this  speculation  is 
largely  the  buying  of  exchange  by  individuals  who  are  betting  on 

[61] 


52  The  Foreign  Exchange  Problem 

a  rise.  This  buying  is  often  compensated  by  the  selling  of  ex- 
change on  the  part  of  other  individuals  who  are  betting  on  a  fall. 
Therefore,  it  constitutes  merely  a  swapping  of  foreign  exchange 
contracts  and  a  shifting  of  Europe's  creditors,  but  not  actually 
an  increase  in  the  total  amount  of  outstanding  credits.  Thus 
the  debtor  countries  cannot  even  gain  the  slight  advantage  of 
more  purchasing  power,  but  are  merely  exposed  to  the  often 
disastrous  exchange  fluctuations.** 

Factors  Favoring  Speculation 

Speculation  in  exchange  is  favored  by  the  fact  (1)  that  the 
purchasing  power  of  a  foreign  bill  of  exchange  cannot  be  defined 
with  any  degree  of  exactness,  except  perhaps  retrospectively; 
(2)  that  these  indefinite  purchasing  power  values  fluctuate  with 
increasing  inflation  or  deflation;  (3)  that  the  credit  conditions 
in  some  European  countries  are  either  uncertain  or  precarious; 
(4)  that  the  political  situation  abroad  at  best  is  complex  and 
that  the  social  unrest  existing  in  many  countries  is  fraught  with 
imponderable  developments;  moreover,  that  contemplated 
changes  in  commercial  treaties  and  the  tariff^  policies  pursued 
may  alter  considerably  both  the  balances  of  trade  and  indebt- 
edness; and,  finally,  (5)  that  there  is  a  large  volume  of  un- 
funded, unsecured  debt  in  the  form  of  bills  of  exchange,  bank 
deposits,   currency,   and  long  term   internal  bonds   and  stock, 

(*»)  Just  as  interference  with  the  free  movement  of  goods  may  cause 
an  undervaluation  of  exchange,  restrictions  upon  the  free  movement  of  and 
dealing  in  foreign  bills  of  exchange  or  currency  may  bring  it  about  that 
the  same  currency  is  quoted  at  widely  varying  prices  in  different  markets 
on  the  same  day.  For  instance,  on  December  80,  1920,  the  quotation  of 
Austrian  crowns  in  Zurich,  Switzerland,  was  Swiss  fcs.  1.66  for  100  Austrian 
crowns  and  in  Berlin  marks  16.87^,  while  in  Vienna  Swiss  fcs.  were 
quoted  0.98  and  marks  10.90%,  on  the  basis  of  100  Austrian  crowns. 
During  the  war,  some  exchanges  were  artificially  stabilized  by  the  re- 
spective foreign  governments,  who  utilized  the  advances  made  by  our  gov- 
ernment to  buy  up  all  bills  offered  below  a  certain  fixed  ("pegged")  rate 
(e.  g.,  $4.76  7/16  for  the  pound).  Lires  have  been  under  the  control  of 
the  National  Exchange  Institute  which,  with  the  assistance  of  the  Federal 
Reserve  Board,  kept  the  rate  fixed  at  6.35  lires  per  doUar.  Furthermore, 
our  own  Federal  Reserve  Board  by  well-conceived  arrangements  with  the 
Argentine,  Spanish,  and  Swiss  governments,  solved  practically  and  advan- 
tageously for  the  U.  S.  Treasury  the  delicate  exchange  problems  which 
arose  as  a  consequence  of  our  heavy  purchases  of  food-stuffs  and  war 
materials  in  these  various  countries  to  meet  the  urgent  needs  of  our 
Expeditionary  Forces. 


No.  11 


United  States  Trade  with  the  United  Kingdom 

BALANCE  (net)  of  merchandise  imports  and  exports  between 
the  United  States  and  Great  Britain,  annually  in  $1,000,000. 

Insert  reduced  to  1/12  of  main  scale. 

For  further  comment  on  this  chart  see  page  114. 

[58] 


54  The  Foreign  Exchange  Problem 

which  may  be  increased  at  will  or  dumped  on  the  exchange 
markets,  without  notice,  at  any  time. 

There  are  drawbacks  to  a  rising  as  well  as  a  falling  exchange. 
Many  European  holders  of  stocks  of  imported  commodities  have 
incurred  heavy  losses  whenever  their  currency  appreciated  sharp- 
ly in  the  neighboring  or  foreign  markets.  Some  of  the  neutral 
countries — Spain  being  the  most  recent  sufferer — ^have  been  in- 
directly hit  through  the  world-wide  fall  in  staples  in  which  they 
had  invested  part  of  their  war  profits  or  which  they  had  bought 
on  credit. 

In  this  connection  it  should  also  be  noted,  that,  all  other 
conditions  being  equal,  a  general  fall  in  merchandise  prices  of 
30%,  for  example,  will  to  that  extent  change  the  balances  of 
trade  of  the  various  countries  and  thus  is  likely  also,  by  modify- 
ing the  balances  of  indebtedness,  to  raise  the  exchanges  of  the 
importing  and  lower  the  exchanges  of  the  exporting  countries. 

Speculation  during  the  decline  of  the  exchanges  accentuated 
the  tendency  toward  "undervaluation".  Similarly,  from  the 
point  of  view  of  future  developments,  it  is  not  improbable  that 
the  prospect  of  European  recovery,  brought  about  by  a  final 
and  workable  settlement  of  European  differences,  will  call  forth 
another  great  volume  of  speculation  to  take  advantage  of  the 
"undervaluation"  now  registered  by  certain  of  the  European  ex- 
changes. In  this  event,  speculation  may  again,  but  in  the  oppo- 
site direction,  amplify  the  upward  swing  and  create  for  a  certain 
period  of  time  an  "overvaluation".  There  will,  however,  be  two 
large  offsetting  factors:  Europe's  floating  debts — unless 
funded  in  the  meantime — ^will  gradually  come  into  the  exchange 
markets,  and  secondly  "overvaluation"  will  stimulate  additional 
exports  to  Europe. 


(Explanation  and  comment  referring  to  Chart  12  next  page.) 


Discount  Rate  of  the  Bank  of  France 

1857 

World  Crisis. 

1861 

Outbreak  of  Civil  War. 

1864 

Austro-Prussian  War  against  Denmark. 

1866 

Outbreak  of  Austro-Prussian  War. 

1870 

Outbreak  of  Franco-Prussian  War. 

1873 

World  Crisis. 

1882 

Financial  difficulties  in  France. 

1889 

Crisis  in  France. 

1898- 

1900     Boer  War. 

1901-2    Financial  stringency  in  Germany. 

1907 

Crisis  in  United  States,  Great  Britain  and 

Germany. 

1914 

Crisis — Outbreak  of  Great  War. 

Discount  Rate  of  the  Bank  of  England 

1825-6     Crisis  in  England 

18S6-7     Crisis  in  England 

1839 

Crisis  in  England. 

1847 

Crisis  in  England. 

1852 

Plethora  of  money. 

1857 

World  Crisis. 

1858 

Depression  after  crisis  of  1857. 

c       1863 

Small  Crisis  in  England. 

1866 

Crisis  in  England. 

1868 

Depression  after  crisis  of  1866. 

1870 

Outbreak  of  Franco-Prussian  War. 

1873 

World  Crisis. 

1878 

Crisis  in  England. 

1881 

Depression. 

1882 

Trouble    with   Egypt,    Turkey,   and   South 

Africa. 

1890 

Crisis   in  England. 

1901-2     Financial  stringency  in  Germany.                            | 

1893 

Crisis  in  United  States  and  England. 

1898-1900     Boer  War. 

•         1901-2     Financial  stringency  in  Germany. 

1907 

Crisis  in  United  States,  Great  Britain  and 

Germany. 

1914 

Crisis — Outbreak  of  Great  War. 

[55] 


No.  12 


Loan  and  Discount  Rates 

(1)  Annual  high  and  low  rate  (%)  of  discount  charged  by  the 
Bank  of  France. 

(2)  Annual  high  and  low  rate  (%)  of  discount  charged  by  the 
Bank  of  England. 

For  explanation  and  comment  on  this  chart  see  previous  page. 


[66] 


VI. 

Factors  which  will  Stabilize  or  Raise  the 
Foreign  Exchange  Quotations 

(a.)     CREDIT. 

"Assistance  given  at  the  present  time  to  tiie 
distressed  countries  of  Europe  would  secure 
commercial  and  political  ties  of  immense  value 
in  the  future,  and  the  inability  to  give  it  would 
mean  a  great  opportunity  lost."50 

To  alleviate  the  pressure  which  has  weighed  upon  the  foreign 
exchanges  ever  since  the  outbreak  of  the  war  and — after  having 
arrested  their  decline — to  arrive  again  at  a  gradual  appreciation 
of  their  levels,  there  is  only  one  effective  way:  Europe  must 
export  sufficiently  to  pay  for  her  imports  and,  in  addition,  to 
liquidate  gradually  her  present  debts.^^  To  this  end  foreign 
investors  must  be  willing  to  assume  the  present  unfunded  debt 
and  become  Europe's  creditors  on  a  long  term  basis,  while  at 
the  same  time  they  extend  additional  further  loans  as  required 
by  Europe  in  order  to  raise  its  present  production.  It  is,  there- 
fore, necessary  to  examine  now  in  some  detail  the  present  funded 
and  unfunded  indebtedness  of  Europe,  with  continued  special 
reference  to  the  United  States. 

Credit  Funded  and  Unfunded  1914-1920 

During  the  war,  Europe  was  able  to  meet  her  adverse  bal- 
ance on  merchandise  account  in  various  ways.  She  sold  back  to 
us  American  and  other  foreign  securities,  especially  South  Ameri- 
can and  Far  Eastern  bonds,  held  by  her.  The  foreign  holdings 
of  American  securities  have  decreased  since  1914  from  about  six 
billion  to  a  figure  which  has  been  variously  estimated  as  ranging 
between  one  and  two  bilHon  dollars.     Her  own  government  and 


(*>)  Mr.  Frederick  C.  Goodenough  (Chairman  of  Barclays  Bank,  Ltd.,) 
in  an  address  delivered  to  the  Parliamentary  Commercial  Committee  of  the 
House  of  Commons  on  June  9,  1920. 

(")  Unfundedrrfloating  debt  contracted  for  a  short  time. 

[57] 


58  The  Foreign  Exchange  Problem 

private  loans^'  were  floated  in  our  market  before  the  entry  of  the 
United  States  into  the  war  and  also  after  credits  from  our  gov- 
ernment had  ceased.  Private  American  capital  placed  abroad  to- 
day in  funded  obligations  amounts  to  over  three  billion  dollars. 
During  and  after  the  hostilities,  the  United  States  government 
made  advances  to  the  allied  nations,  and  it  now  holds  about  ten 
billion  dollars  of  such  foreign  bonds  and  long  term  notes.  All  this, 
however,  was  insufficient  to  meet  the  excess  of  imports  from  the 
United  States,  and  the  deficit  was  made  up  in  unfunded  loans. 
European  buyers  did  not  pay  cash  for  all  of  their  imports  from 
the  United  States,  but  borrowed  the  necessary  amounts  in  open 
accounts  with  American,  and  to  some  extent  British,  producers, 
manufacturers,  and  banks.  The  War  Finance  Corporation  and 
later  the  companies  formed  under  the  Edge  Act  facilitated  con- 
siderably the  extension  of  these  credits.  Furthermore,  Europe 
received  indirectly  advances  from  all  foreigners  who  opened  de- 
posit accounts  in  European  banks,  or  from  those  who  bought  bills 
of  exchange  or  currency  for  either  investment  or  speculation. 
Now,  however,  although  Europe  is  still  in  need  of  goods,  this 
unfunded  credit  has  reached  such  large  proportions  that  for  the 
present  it  is  not  being  extended  further  to  any  considerable 
degree. 

Present  Attitude  respecting  Foreign  Short  Term  Credits 

For  this  there  are  two  reasons:  First,  those  who  bought 
exchange  for  investment  or  speculation  were  unwilling,  and  later, 
with  the  general  fall  in  prices  of  merchandise,  in  some  instances, 
unable  to  increase  their  commitments ;  second,  the  burden  of  the 
credit  extended  by  manufacturers,  exporters,  investors,  and 
speculators  in  currency  or  exchange  was  partly  borne  by  the 
banks.  Those  producers  and  exporters  who  have  tied  up  part 
of  their  working  capital  in  open-account  advances  to  foreign 
importers  have  been  obliged  to  apply  for  financial  accommoda- 
tion which  otherwise  they  would  not  have  needed.  These  loans 
have  now  been  restricted  and,  in  addition,  the  banks  have  in  many 
cases  reduced  the  outstanding  credits   on  their  own  account. 

C®)  We  shall  designate  by  private  loans,  all  loans  issued  by  other  enti- 
ties than  governments  or  not  accompanied  by  government  guarantees. 


Factors  which  will  Stabilize  or  Raise  the  Foreign  Exchanges     59 

The  inflation  and  the  consequent  rise  in  prices  in  our  country 
in  the  year  and  a  half  preceding  approximately  July  1,  19^0 
is  traceable  to  a  certain  extent  to  the  unfunded  debt  of  Europe. 
The  burden  of  paying  for  Europe's  excess  imports  has  been 
borne  not  alone  by  the  manufacturers,  the  exporters,  the  banks, 
the  investors,  and  the  speculators  in  foreign  securities,  cur- 
rencies, and  exchange,  but  also,  in  a  limited  measure,  by  the 
whole  nation  in  the  form  of  the  higher  cost  of  living. 

It  has  been  explained  why  the  extension  of  short  term  or 
unfunded  credit  to  Europe  has  been  reduced;  the  question  re- 
mains as  to  why  further  long  term  funded  credit  is  not  forth- 
coming in  sufficient  amounts  at  this  moment. 

Foreign  Funded  Obligations  held  by  the  United  States 

For  this  purpose  it  is  necessary  to  analyze  the  probable 
make-up  of  our  international  balance  sheet  during  the  next  few 
years.  American  capital  invested  abroad  today  in  foreign  obliga- 
tions, the  greater  part  of  which  is  funded,  amounts  to  $17,000,- 
000,000,  over  against  which  there  are  held  abroad  about 
one  to  two  billion  dollars  of  American  securities,  so  that  the  net 
capital  invested  abroad  is  about  $15,000,000,000.  The  interest 
on  this  sum — about  $800,000,000 — if  fully  and  regularly  paid, 
exceeds  largely  the  annual  invisible  debits,  the  two  most  sig- 
nificant items  of  which  were,  according  to  recent  estimates,  in 
1919,  $300,000,000'^  for  immigrants'  remittances  and  $50,000,- 
000  for  tourists'  expenditures.  The  latter  item  may  be  expected 
CO  reach  again  much  higher  figures  during  the  next  few  years. 
Freight  charges  have  passed  to  the  credit  side  but  are  not  very 
important  as  yet.  Banking  and  insurance  charges  are  believed 
to  balance  approximately.'*  Thus  far,  then,  there  would  be  a 
strong  balance  in  our  favor — about  $400,000,000 — which  would 
have  to  be  off^set  by  an  excess  over  exports  of  imports  of  merchan- 
dise and/or  gold  into  the  United  States.''  However,  by  agree- 
ment between  the  United  States  Treasury  and  the  Allies,  inter- 

C^)  We  believe  this  figure  to  be  too  low  rather  than  too  high;  all  these 
figures  are,  of  course,  approximate. 

(")  Chase  Economic  Bulletin  of  Oct.,  1920.     (Dr.  B.  M.  Anderson,  Jr.) 
l^^)  It  should  be  remembered  in  this  connection  that  in  1920  our  mer- 
chandise exports  aggregated  $8,228,759,000,  and  our  imports  $5,279,898,000. 


No.  13 


United  States  Trade  with  France 

BALANCE  (net)  of  merchandise  imports  and  exports  between 
the  United  States  and  France  annually  in  $1,000,000. 

Insert  reduced  to  1/16  of  main  scale. 

For  further  comment  on  this  chart  see  page  114. 

[60] 


Factors  which  will  Stabilize  or  Raise  the  Foreign  Exchanges     61 

est  payment  on  the  debt  held  by  the  United  States  government 
(amounting  to  about  $10,000,000,000)  has  been  suspended  until 
1923.  Thus,  our  country  is  at  present  a  creditor  for  practically 
only  about  $5,000,000,000,  instead  of  $15,000,000,000,  which 
sum  after  1923  with  accrued  interest  will  aggregate  about  seven- 
teen billion  dollars  involving  annual  interest  payments  of  about 
$900,000,000. 

Until  1923,  therefore,  barring  any  possible  change  in  the 
amount  of  the  funded  or  unfunded  debt,  and  not  taking  into 
account  for  the  moment  the  balance  which  may  be  due  us  if  our 
exports  continue  to  exceed  our  imports,  the  payment  by  our 
foreign  debtors  of  the  interest  owing  us  on  account  of  indebt- 
edness ($250,000,000)  is  more  than  offset  by  the  amounts  due 
them  on  account  of  tourists'  expenditures,  immigrants'  remit- 
tances, etc.  (over  $350,000,000).  From  the  point  of  view  of  the 
future  course  of  the  foreign  exchanges,  we  may  conclude  that 
until  1923  we  can  almost  disregard  as  operating  factors  the 
various  items  which  we  have  quoted  and  that  the  changes  in 
foreign  indebtedness  and  foreign  trade  will  be  the  principal 
elements  upon  which  we  shall  have  to  concentrate  our  attention. 

Foreign  Unfunded  Obligations  held  by  the  United  States 

Outside  of  the  annual  net  balance  of  indebtedness  of  $400,- 
000,000  or  more,  which  Europe,  after  1923,  will  have  to  cover, 
she  must  be  prepared  to  meet,  at  some  time  or  other,  her  floating 
indebtedness  in  the  form  of  bank  deposits,  foreign  currency,  and 
exchange  which  for  the  United  States  alone  has  been  estimated 
to  aggregate  $3,600,000,000.  A  considerable  part  of  this  sum 
is  made  up  of  speculative  holdings.  In  addition,  a  certain  part 
of  the  funded  private  debt  of  Europe  held  here  or  in  other  coun- 
tries was  bought  for  speculation  rather  than  investment.  All 
these  holdings,  unless  funded,  may  be  expected  to  appear  on  the 
exchange  markets  at  some  time,  and  notably  when  the  specula- 
tions show  a  substantial  profit — or  loss. 

The  unfunded  credits,  open  accounts,  and  bills  due  by  for- 
eign importers,  not  only  in  Europe,  but  also  in  Central  and 
South  America  and  the  Far  East,^**  will  gradually  fall  due  and 

C")  It  should  be  noted  that  the  fall  in  prices  and  the  rise  of  dollar  ex- 
change in  foreign  countries  have  left  many  exporters  with  stocks  of  goods 
or  with  balances  on  their  hands  in  foreign  countries,  held  either  on  account 


62  The  Foreign  Exchange  Problem 

must  be  covered  unless  further  extension  of  the  maturity  dates 
should  be  agreed  to. 

Since  Europe  cannot  without  inconvenience  decrease  her 
imports  and  cannot  increase  her  exports  in  the  near  future  with- 
out foreign  assistance  to  any  considerable  extent,  it  appears 
that  further  credits  must  be  extended  in  some  form  or  other, 
not  only  in  order  to  finance  the  future  expoi-ts  to  Europe,  but 
also  to  consolidate  the  floating  debt,  which,  as  a  sword  of 
Damocles,  overhangs  the  foreign  exchange  markets. 

The  question  of  granting  these  further  credits  must  be  exam- 
ined both  from  the  American  and  the  European  side. 

Present  Attitude  respecting  further  Funded  Loans 

It  is  admitted  that,  in  the  future,  rather  than  from  the  bank- 
ing assets  or  the  active  working  capital  of  business  houses, 
needed  credits  must  come  in  a  larger  proportion  from  the  inves- 
tor. This  presupposes :  ( 1 )  That  there  is  on  hand  in  this  coun- 
try enough  liquid  income  to  absorb  in  adequate  amounts  the 
long  term  bonds  offered  by  prospective  European  buyers  of  the 
commodities  and  goods  held  for  sale  by  the  American  farmers, 
planters,  manufacturers,  and  exporters;  (2)  that  our  people 
will  be  able  and  willing  to  save  sufficiently  in  the  future  in  the 
interest  of  that  important  part  of  the  community  which  directly 
or  indirectly  thrives  on  foreign  trade  and,  for  that  matter,  for 
the  ultimate  benefit  of  the  whole  nation  whose  future  prosperity 
may  largely  depend  on  it.^^  The  amount  of  surplus  wealth 
has  been  considerably  decreased  by  the  recent  fall  in  prices. 
The  farmers  alone,  despite  record  crops,  are  said  to  have 
experienced  a  loss  in  purchasing  power  of  six  to  eight  billion 
dollars.  It  has  been  asserted  that  additional  foreign  reconstruc- 
tion loans  could  not  be  floated  because  there  is  not  sufficient  idle 
surplus  capital.     Yet  the  losses  incurred  by  the   recent  drop 

oif  cancelled  orders  or,  as  in  the  case  of  Australasia  and  South  Africa, 
because  during  some  time  it  was  more  difficult  to  sell  drafts  against  ship- 
ments to  these  destinations  or  to  secure  at  reasonable  terms  cover  in 
sterling  or  dollar  exchange. 

{'")  The  probable  carry-over  of  raw  cotton  in  the  U.  S.  at  the  end  of 
the  present  crop  year  has  been  estimated  to  amount  to  7,000,000  bales,  more 
than  one-half  of  last  year's  crop. 


Factors  which  will  Stabilize  or  Raise  the  Foreign  Exchanges     68 

in  prices  appear  to  exceed  the  amount  which  would  have  been 
necessary  to  cover  the  whole  of  Europe's  unfunded  indebtedness. 
It  has  been  explained  above  why  short  term  credit  is  no  longer 
forthcoming  to  a  sufficient  extent  to  bridge  the  gap  between 
present  supply  and  future  production.  Plans  for  enlisting  the 
desirable  co-operation  of  the  investor  on  a  larger  scale  are  being 
put  forth  daily.  Assuming  that  the  annual  savings  available  in 
the  United  States  are  adequate  to  cover  not  only  our  still  im- 
portant domestic  requirements,  but  also  legitimate  foreign  needs, 
there  remain  other  weighty  factors  which  have  to  be  considered. 

Prerequisites  to  the  Extension  of  further  Credits  or  Loans 

In  approaching  the  question  of  financial  assistance  to 
Europe,  distinction  must  be  made  between  loans  to  private  indi- 
viduals, firms,  or  corporations,  and  loans  to  nations  or  to  gov- 
ernment agencies.  Where  a  private  individual  is  the  borrower, 
an  investigation  is  made  of  his  integrity,  his  assets  and  liabili- 
ties, his  line  of  business  or  product,  and  the  actual  or  prospective 
market  thereof.  One  endeavors  to  measure  the  individual's  pro- 
ductive ability  and  to  determine  whether  he  is  entitled  to  the 
amount  of  credit  sought,  and  whether  he  is  able  to  meet  the 
interest  charges  thereon,  in  the  first  place,  and  repay  the  capital 
ultimately. 

Production 

The  grant  of  a  loan  to  a  foreign  government  is  dependent 
chiefly  on  three  elements:  (1)  the  capacity  of  the  nation  to 
produce;  (2)  its  ability  to  save  over  and  above  consumption; 
and,  (3)  the  status  of  social  solidarity  enabling  the  imposition 
of  the  required  taxes.  A  country's  capacity  to  produce  depends 
on  its  area  and  geographical  location,  on  its  population,  and 
finally  on  the  amount  and  kind  of  its  national  wealth  and  its 
technique  of  production. 

Saving 

It  is  considerably  more  difficult  to  establish  a  nation's  capacity 
to  economize.    The  extent  of  the  growth  of  savings,  not  in  terms 


No.  14 


22Ji 


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United  States  Trade  with  Germany 

BALANCE  of  merchandise  imports  and  exports  between  the 
United  States  and  Germany  annually  in  $1,000,000. 

For  further  comment  on  this  chart  see  page  116. 
[64] 


Factors  which  will  Stabilise  or  Raise  the  Foreign  Exchanges     65 

ot  money,  but  in  terms  of  goods — ^which  failing  gold  or  services 
are  the  only  means  of  paying  off  foreign  debts — is  a  very  elusive 
quantity.  It  is  generally  computed  by  taking  the  figure  show- 
ing the  annual  national  income,  from  which  is  subtracted  the 
consumption  of  the  nation  during  the  year.  From  the  remainder, 
a  sum  is  set  aside  to  cover  necessary  repairs  and  improvements 
on  the  domestic  productive  machinery  and  all  capital  charges 
on  the  already  existing  foreign  debt.  The  balance  in  gold  or 
goods  may  be  estimated  to  be  the  sum  available  for  meeting  fur- 
ther foreign  obligations. 

Taxation 

Taxation  power  is  even  more  difficult  to  establish.  The  lender 
is  interested  less  in  the  temporary  financial  situation  of  a  nation, 
than  in  the  ability  to  produce  and  segregate  a  margin.  Nations 
vary  in  the  taxability  of  property.  The  nature  of  property 
differs,  and  is,  therefore,  not  equally  susceptible  of  being  reached 
by  taxation.  The  psychology  and  the  civic  education  of  the 
people  is  not  the  same,  and  finally,  political  conditions  allow 
certain  nations  to  tax  to  the  limits  of  physical  possibility,  while 
others  dare  not  tax  so  severely  for  fear  of  an  overthrow  of  the 
government,  and  social  revolution. 


Yield 

Still  assuming  political  stability,  the  question  of  yield  is  com- 
plicated by  the  monetary  situation  in  the  creditor  countries,  the 
most  prominent  of  which  is  the  United  States.  Even  at  high 
rates,  there  is  always  a  great  demand  for  capital  from  our  own 
industry.  Besides  being  handicapped  because  many  of  our 
capitalists  still  prefer  domestic  securities,  the  European  in- 
dividuals or  governments  bidding  for  capital  have  to  compete 
not  only  with  American  and  other  non-European  borrowers,  but 
also  with  our  own  federal  government,  states,  municipalities, 
public  service,  railroad,  and  industrial  corporations;  the  result 
is  higher  interest,  and  syndicate  charges.  It  is,  therefore,  doubly 
necessary  for  Europe  to  use  credit  as  sparingly  as  possible. 


66  The  Foreign  Exchange  Problem 

Application  of  Loans 

The  needs  of  the  borrowers  are  carefully  examined  not  only 
as  to  total  volume  but  also  as  to  the  intended  use  of  the  proceeds. 
Funds  are  granted  to  applicants  only  after  careful  scrutiny  of 
the  eventual  purpose  of  the  loan.  It  is  believed  in  some  quarters 
that  Europe's  past  borrowings  have  not  been  so  fruitful  in  actual 
economic  results  as  they  might  have  been.  Some  of  the  credit 
that  has  been  granted,  instead  of  being  used  to  buy  raw  materials 
with  which  to  produce  exportable  goods,  appears  to  have  been 
employed  to  buy  luxuries,  or  to  have  been  merely  transferred  into 
the  borrowing  country,  or  to  other  creditors.  Undiscriminating 
credit  extended  from  one  source  is  a  disadvantage  to  all  other 
lenders,  if  it  is  not  put  to  the  wisest  use  for  the  benefit  of  all. 

Exchange  and  the  Lender 

From  the  special  viewpoint  of  the  influence  of  such  credits 
on  the  foreign  exchanges,  some  technical  points  are  worthy  of 
notice.  Assuming  that  the  political  situation  is  clear  and  stable, 
that  international  contracts  are  respected  and  promise  to  be 
undisturbed,  lenders  will  not,  and  cannot  be  expected  to  give  up 
their  savings  if  the  borrower,  although  he  lives  up  to  the  letter 
of  his  contract,  pays  interest  charges  and  principal  in  monies 
which  may  have  less  purchasing  power  to  an  incalculable  extent 
than  tfhe  funds  originally  loaned.  The  investors  as  a  whole 
cannot  be  expected  to  bear  the  exchange  risk  today,  although 
some  individuals  may  be  willing  and  anxious  to  do  so.  Formerly 
the  risk  of  exchange  was  borne  by  the  lender  if  desired ;  however, 
the  recent  experiences  of  holders  of  foreign  securities  in  this 
respect  have  not  been  encouraging. 

The  capitalist,  who  in  the  past  invested  in  obligations  pay- 
able in  European  currencies,  receives  today  his  interest  in  depre- 
ciated paper  money.  His  annual  return  is  diminished  more  or 
less  considerably,  and  in  case  of  reimbursement  by  the  borrower, 
or  in  case  of  sale  at  home  or  abroad,  he  suffers  a  heavy  loss. 

Exchange  and  the  Borrower 

The  financial  position  of  the  borrower  (nation  or  individual) 
is  technically  unchanged,  although  practically  the  inflation  that 


Factors  which  will  Stabilize  or  Raise  the  Foreign  Exchanges     67 

has  taken  place  in  the  meantime  and  the  increased  fiscal  capacity 
(as  calculated  in  paper  money),  render  it  easier  to  pay  the 
interest  or  amortize  the  capital  in  his  depreciated  currency. 
If  the  loan  has  been  contracted  in  foreign  currency,  the 
situation  of  the  borrower  is  different.  He  will  have  to  pay  a 
higher  sum  in  case  his  own  currency  at  the  time  of  maturity  or 
repurchase  of  the  loan  or  the  payment  of  the  coupons  is  quoted 
in  the  international  exchange  markets  lower  than  at  the  date  of 
issue  or  sale.  If  the  borrower's  currency  has  declined  in  the 
foreign  markets,  it  will  be  advantageous  for  him  to  reimburse,  by 
anticipation,  if  legally  he  can,  the  old  loans  contracted  in  his  own 
currency  at  a  time  when  it  was  at  or  above  par  abroad.  In  this 
connection  it  has  been  affirmed  that  the  more  foreign  countries 
increase  their  foreign  loans,  the  more  they  are  tempted  to  inflate 
their  money  at  home.  If  a  loan  payable  in  Belgian  francs,  con- 
tracted when  Belgian  francs  were  worth  eight  francs  to  the  dol- 
lar, is  paid  off  at  a  time  when  the  value  of  Belgian  francs  has 
fallen  to  fifteen  francs  per  dollar,  this  would  appear  to  be  an  ad- 
visable and  profitable  transaction.  Here  would  be  one  advantage 
of  inflation. 

The  alternative  to  having  the  purchaser  of  the  bonds  bear  the 
exchange  risk,  is  to  issue  the  loan  in  dollars ;  however,  the  bor- 
rower too,  may  under  prevailing  conditions,  hesitate  to  assume 
the  exchange  risk.  If,  for  the  remittance  abroad  of  capital  and 
interest,  the  dollar  costs  the  borrower  more  to  acquire  than  it 
was  worth  at  the  time  the  loan  was  contracted,  the  interest  and 
amortization  charges  are  proportionately  increased.  On  the 
other  hand,  should  the  premium  on  the  dollar  or  sterling  drop, 
these  same  charges  will  be  proportionately  less  burdensome. 

Secured  Loans  to  Private  Borrowers 

More  important  than  the  return,  the  exchange  risk,  and  the 
application  of  the  proceeds  of  the  credits  or  loans,  is  the  ques- 
tion of  the  security  behind  the  obligation. 

In  the  case  of  short  term  credits  granted  to  private  bor- 
rowers, both  bankers  and  exporters  often  cover  themselves  by 
retaining  a  lien  on  the  goods  exported  even  to  their  ultimate  sale 


No.  15 


The  Merchandise  Balance  of  France 

BALANCE  (net)  of  imports  and  exports  of  merchandise 
(special  trade)  between  France  and  the  rest  of  the  world  annually 
in  $1,000,000. 

Rate  of  conversion  19.3  cents  per  franc. 

Insert  reduced  to  1/20  of  main  scale. 

For  the  period  of  1789-1797,  figures  for  the  years  1789  and 
1792  only  available;  no  figures  for  the  years  1811-1814,  inclusive. 

For  further  comment  on  this  chart  see  page  115. 
[68] 


Factors  which  will  Stabilize  or  Raise  the  Foreign  Exchanges     69 

after  conversion  ("finishing  credits").  In  cases  where  the  funds 
are  actually  deposited  with  banks  or  where  the  credits  are  sur- 
rounded by  bank  or  government  guarantees,  such  collateral  is 
often  dispensed  with.  The  question  is  of  much  deeper  signi- 
ficance for  the  investor  in  long  term  loans.  Should  not  the 
European  private  borrower  besides  showing  ability  to  pay  the 
interest  charges  and  part  of  the  principal,  furnish  also  tangible 
security  in  the  form  of  a  mortgage  on  unencumbered  property 
(mines,  factories,  etc.)  ?  Will  any  such  security  tendered  to  the 
American  investors  protect  them  efficaciously  against  the  pos- 
sibilities of  the  failure  on  the  part  of  the  borrowers  (large  indus- 
trial corporations,  railroad  companies,  etc.),  to  meet  their  obli- 
gations, whether  they  be  due  to  internal  business  difficulties, 
to  inflation  by  their  nations,  to  adverse  movements  in  the  ex- 
changes, or  to  political  events.? 

Secured  Loans  to  Governments 

In  the  case  of  nations,  the  security  may  be  of  various  kinds. 
The  borrower  may  pledge  a  form  of  revenue  to  the  creditor ;  the 
yield  of  certain  taxes  or  customs  may  be  handed  over  to,  or 
administered  by  the  representatives  of  the  foreign  investors. 
Nations  may  also  offer  as  security,  forests,  railroads,  power 
plants,  or  even  territory  (free  of  prior  liens  on  property  held 
by  their  own  citizens  whom  they  would  indemnify).  The  econo- 
mic section  at  the  first  Assembly  of  the  League  of  Nations  in 
December  1920,  as  a  first  constructive  move  in  this  direction 
has  recommended  the  establishment  of  an  international  commis- 
sion which  would  act  as  trustee  for  assets  so  pledged  by 
credit-seeking  powers  on  behalf  of  their  citizens. 

If  satisfactory  security  is  available,  it  is  questionable  on  the 
one  hand  whether  the  European  governments  or  individual  bor- 
rowers are  willing  to  furnish  such  special  collateral.  The  selling 
of  European  securities  in  foreign  countries  has  brought  with  it 
an  increasing  control  over  local  European  industries  by  aliens, 
which  has  often  been  resented  because  it  has  hurt  old  vested  in- 
terests. 


70  The  Foreign  Exchange  Problem 

On  the  other  hand,  even  though  the  physical  security  may 
be  considered  ample,  the  American  capitalist  may  require  more 
definite  assurances  that  the  government  of  the  United  States 
(or  some  international  agency  if  it  is  able  to  do  so),  is  pre- 
pared to  enforce,  if  necessary,  the  delivery  of  the  security 
or  its  proceeds  in  case  of  default  by  any  of  the  contracting 
parties. 

International  Situation  the  Overwhelming  Factor 

In  some  cases  it  may  not  even  be  so  much  the  question  of 
finding  the  physical  basis  of  the  security;  the  collateral  after 
all  is  intended  only  to  protect  against  loss  in  case  the  borrower 
cannot  or  will  not  live  up  to  his  contract,  which  is  expected  to 
be  the  exceptional  case.  The  large  and  all-important  question 
is,  whether  the  political  and  economic  conditions  abroad  warrant 
encouragement  of  foreign  investments  at  this  time.  Is  the  whole 
European  policy  such  as  to  promote  readjustment.?  Is  there  a 
sincere  endeavor  to  return  to  sound  economic  principles.'*  Some 
blame  the  present  imbroglio  on  the  redistribution  of  territory 
and  movable  wealth  without  regard  to  the  economic  effect  of 
isolating  old  productive  centers  from  their  connections;  others 
criticize  the  imposition  of  embargoes,  regulations,  immigration 
bans ;  the  continuation  of  the  spirit  of  animosity  and  distrust ; 
the  extravagant  government  expenditures,  and  the  still  undecided 
reparation  problem.  Will  not  all  these  matters  together — ^if 
they  are  not  remedied  at  the  outset — either  delay  or  prevent  the 
various  European  countries  from  reaching  their  highest  produc- 
tive capacity  even  with  ample  outside  support? 

Europe's  Obligations  and  the  Future  of  our  Foreign  Trade 

'  In  the  cost  of  many  manufactured  goods  the  price  of  the 
raw  material  is  the  smaller,  the  compensation  of  labor,  the  over- 
head and  all  other  charges,  the  larger  item.  The  proceeds  of  a 
loan,  in  the  last  analysis,  are  turned  over  to  the  borrower  in  the 
form  of  raw  materials  furnished  either  by  the  lender  or  some 
other  country.  Eventually  these  loans  are  paid  off  with  raw 
materials  produced  and  articles  manufactured  in  the  borrower's 


Factors  which  will  Stabilize  or  Raise  the  Foreign  Exchanges     71 

country.  The  latter  are  invoiced  to  the  creditor  and  other 
buyers  at  the  original  cost  of  the  raw  material,  increased  by 
the  wages  of  labor,  overhead  charges,  interest  on  the  loan,  taxes, 
export  duties,  sinking  fund,  and  a  profit.  By  extending  such 
loans  a  creditor  country  merely  provides  its  debtor  with  work 
and  the  means  of  living  for  part  of  its  citizens,  and  in  so  doing, 
indirectly,  to  a  certain  extent,  with  the  means  of  paying  interest 
on,  and  gradually  redeeming  its  indebtedness  to  its  creditors. 

Particular  stress  should  be  laid  on  the  fact  that,  provided  the 
debtor  country  can  sell  its  manufactured  products  to  the  cred- 
itor or  some  other  solvent  buyer,  the  selling  price  of  the  manu- 
factured product  has,  broadly  speaking,  to  be  raised  by  the 
amount  of  the  interest  and  the  sinking  fund. 

In  ordinary  mercantile  transactions,  the  seller  on  cif  (cost. 
Insurance,  freight)  terms,  if  he  does  not  prepay  the  freight, 
often  deducts  it  from  the  invoice  rendered  to  the  buyer  and  leaves 
it  to  the  latter  to  settle  the  freight  on  arrival  of  the  merchan- 
dise. Similarly,  for  purposes  of  illustration,  we  might  imagine 
that  the  debtor  invoice  the  product  manufactured,  less  the 
amount  of  interest  and  the  amortization  charges  by  reason  of  the 
capital  owed.  Viewing  the  situation  from  this  angle,  the  creditor 
would,  after  all,  pay  to  himself,  through  the  proportionate 
increase  in  price  of  the  manufactured  product,  the  interest  and 
capital  charges  due  him  by  the  debtor."®  This  means  practically 
that  if  the  creditor,  at  the  outset,  chooses  to  cancel  the  original 
debt  and  interest  and  to  pay  for  the  manufactured  product  at  a 
price  which  would  not  include  these  same  interest  and  capital 
charges,  the  real  net  price  paid  by  the  creditor  and  obtained  by 
the  debtor  for  the  manufactured  product  would  be  unchanged. 
The  paramount  question  arises,  whether  for  the  internal  economy 
of  the  creditor  country  and  for  the  protection  of  its  home  indus- 
tries, it  is  better  to  pay  the  increased  price  (including  the  inter- 
est on  previous  debts)  or  to  cancel  the  original  debt  officially,''' 
without  making  any  new  loans  of  raw  materials  and  without  con- 
sequently being  obliged,  in  order  to  recover  the  amount  of  the 

C^)  This,  of  course,  is  not  to  be  taken  literally.  The  individual  holder 
of  foreign  securities  pays  himself  his  own  interest  only  in  so  far  as  he  buys 
goods  manufactured  with  the  proceeds  of  bonds  held  by  him. 

C^')  Assuming  that  such  a  course  is  acceptable  to  the  borrower. 


72  The  Foreign  Exchange  Problem 

old  and  new  loans,  to  absorb  immense  quantities  of  manufactured 
foreign  articles. 

On  the  other  hand,  if  the  creditor  country,  for  the  protection 
of  its  industries,  erects  a  tariff  wall  to  limit  the  entry  of 
foreign  goods,  will  it,  nevertheless,  be  able  to  collect  ultimately 
its  outstanding  loans?  If  it  does  not  impose  or  raise  import 
duties,  will  it  be  able  to  weather  the  flooding  of  its  markets 
with  foreign  articles  ?  In  spite  of  the  interest  charges,  the  heavy 
taxes,  and  the  high  prices  paid  for  the  raw  material  by  the 
foreign  manufacturers,  the  selling  price  of  such  foreign  products 
may  be  below  the  cost  price  of  the  identical  domestic  product  at 
home,  due  not  only  to  the  depreciated  exchanges,  but  also  due 
to  the  lower  wages  and  the  lower  standard  of  living  abroad. 
Furthermore,  the  cost  price  of  the  domestic  product  may  be 
relatively  higher  (notwithstanding  the  perhaps  more  efficient 
technical  methods  and  higher  individual  output),  because  of  the 
higher  standard  of  living  in  the  creditor  country.^® 

Considered  in  this  light,  the  interest  charges  added  to  the 
price  of  the  products  manufactured  abroad  offset  to  a  certain 
extent  this  disadvantage.  If  former  loans  are  not  cancelled  and 
interest  charges  have  to  be  calculated  by  the  debtor  as  one  of 
the  important  items  of  the  balance  of  his  foreign  indebtedness, 
this  factor  will  allow  the  creditor  countries  to  compete  in  the 
disposal  of  their  own  products  on  more  equal  terms  with  their 
foreign  debtors  in  the  other  markets  of  the  world. 


(«>)  The  following 

table  shows  the 

average  daily  output,  and  wage  of  a 

coal  miner  in  the  various  countries: 

U.8. 

France. 

8Tpain. 

Germany. 

1913  Output. 4200 lbs. 

1618  lbs. 

1188  lbs. 

2134  lbs. 

1919    Output. 4500 lbs. 

968  lbs. 

680  lbs. 

1254  lbs. 

Increase    1% 

* 

Decrease 

36.2% 

42.7% 

41.2% 

1913  Wage. .     $2.72 

6  Fes.— $1.16 

3.80  Pts.— $0.73 

6.50  Mks.— $1.30 

1919  Wage..     $4.60 

16  Fes.— $2.89 

10.70  Pts.— $2.06 

30.00  Mks.— $7.14 

Increase    166% 

249% 

282% 

549% 

The  increase  in  wages  is  oflFset  to  a  greater  or  lesser  extent  by  the  higher 
cost  of  living  which,  of  course,  has  risen  in  different  proportions  in  the  dif- 
ferent countries.   (U.  S.  rise  in  prices  114%;  France  258%). 


{Explanation  and  comment  referring  to  Chart  16  next  page.) 

Loan  and  Discount  Rates 

United  States:     Below. 

Annual  average  New  York  rates. 

.  60  days  rates   (%)   till  1859;  prime 

two-name  60  days  rates  1860-1906;  prime  two- 
name  60-90  days  rates  1907- 

Call  rates  (%)  tiU  1874;  call  rates 

at  the  Stock  Exchange  1875. 

Germany :    Above. 

Annual  average  of  the  rate  of  dis- 
count (%)  of  the  Reichsbank. 

Annual  average  of  the  market  rate 

(%)  of  discount  in  Berlin. 

No  rates  1915-1919. 

UNITED  STATES  INTEREST  RATES 

1834     Stringency  in  money  market  on  account  of 

government  withdrawal  of  deposits. 

1836  Stringency  in  money  market  in  connection 
with  closing  of  the  Second  Bank  of  the 
United  States. 

1837  World  Crisis. 
1839  Crisis  in  the  United  States. 
1848  War  with  Mexico. 
1857  World  Crisis. 
1860  Crisis  on  Outbreak  of  Civil  War. 

1869  Stringency  in  connection  with  speculation 
in  gold. 

1873  World  Crisis. 

1887  Some  Bank  Failures  in  the  United  States. 

1890  Crisis. 

1893  Crisis  in  Great  Britain  and  United  States. 

1903  Crisis  in  United  States. 

1907  Crisis  in  United  States. 

1913  Balkan  Wars. 

GERMAN  INTEREST  RATES 
1847-8  Political  Disturbances. 
1857     World  Crisis. 

1864     Austro-Prussian  War  against  Denmark. 
1866     Crisis    in    England    and    Austro-Prussian 
War. 

1870  Outbreak  of  Franco-Prussian  War. 
1873     Crisis. 
1890     Crisis  in  England. 
1898-1900     Boer  War. 
1901-2     Financial  stringency  in  Germany. 

1906  Crisis  in  Germany. 

1907  World  Crisis. 
1913     Balkan  Wars. 

[73] 


No.  16 


LOAN  AND  DISCOUNT  RATES 


For  explanation  and  comment  on  this  chart  see  previous  page. 


[74] 


VI. 

Factors  which  will  Stabilize  or  Raise  the 
Foreign  Exchange  Quotations 

(b)     DEFLATION. 

Assuming  that  purchases  in  Europe  could  be  and  were  in- 
creased, that  present  trade  restrictions  were  removed,  and  that 
credit  to  European  countries  could  and  would  be  extended  along 
the  lines  discussed  in  the  previous  chapter,  such  measures  would 
aid  only  temporarily  in  correcting  any  actual  depreciation  which 
may  exist  beyond  the  present  purchasing  power  of  the  exchanges. 
On  the  basis  of  our  analysis,  it  must  be  evident  that  only  if  (as 
a  result  of  imports  from,  or  extension  of  credits  to  Europe) 
the  merchandise  equivalent  of  European  currencies  was  perma- 
nently enhanced  by  increased  production  abroad,  would  the  "gold 
discount"  be  actually  reduced.  As  a  matter  of  fact,  in  the 
present  economic  state  of  the  world,  such  imports  or  credits 
cannot  be  effected  on  a  scale  large  enough  to  raise  the  real  value 
of  debased  currencies  lastingly  unless  they  are  spread  over  a 
period  of  years.  Furthermore,  the  immediate  productive  capac- 
ity of  the  debtor  countries  is  limited.  It  would  appear,  and  it 
has  already  been  amply  emphasized  by  all  competent  students 
of  these  questions,  that  the  principal  step  to  be  taken  toward 
improving  the  foreign  exchange  situation,  is  to  put  a  stop  to 
further  inflation.  This  will  prevent  the  further  falling  of  the 
purchasing  power  value  and  at  the  same  time  eliminate  one  factor 
which  has  directly  (by  abnormal  price  changes)  and  indirectly 
(by  favoring  speculation)  caused  exchange  fluctuations.  While 
inflation  proceeds,  preventing  the  vitally  necessary  readjustment 
of  production  and  consumption,  which  alone  will  raise  the  pur- 
chasing power,  there  would  seem  to  be  no  hope  for  any  per- 
manent progress  toward  rehabilitation  and  amelioration  of  the 
exchanges. 

[75] 


76  The  Foreign  Exchange  Problem 

Public  Economy 

We  have  seen  that  one  of  the  chief  causes  of  inflation  is  the 
incessant  demand  for  money  on  the  part  of  the  governments. 
Even  a  very  cursory  examination  of  conditions  will  make  it  clear 
that  the  European  nations  cannot,  with  impunity,  continue  to 
incur  tremendous  expenditures  which  are  only  partly  covered  by 
taxation  or  by  loans  subscribed  from  real  surplus  income.  How- 
ever justified  and  in  a  certain  measure  indispensable  these  ex- 
penditures may  be,  they  are  today  out  of  proportion  to  the 
financial  capacity  of  the  various  peoples,  and  to  that  extent  a 
direct  serious  hindrance  to  any  revival  of  production  and  trade. 
The  channels  through  which  new  quantities  of  artificial  pur- 
chasing power  were  created,  in  many  cases  not  for  productive 
purposes,  must  be  hermetically  closed.  The  budgets  must  be 
permanently  balanced.  The  public  "standard  of  spending" 
must  be  reduced. 

The  power  of  production  forms  the  very  source  of  effective 
taxation.  The  burden  imposed  upon  the  citizens  to  meet  the 
expenses  of  the  state  must  not  exceed  the  highest  practical  limits. 
Too  heavy  taxation  reduces  production  and  very  often  raises 
both  the  amount  and  the  velocity  of  expenditures.  It  tends  to 
handicap  legitimate  expansion,  as  it  prevents  the  business  man 
from  putting  back  into  his  enterprise  his  excess  profits  for  normal 
upkeep  and  growth.  Finally,  inasmuch  as  most  trades  are  car- 
ried on  partly  on  borrowed  capital,  the  demands  of  the  internal 
revenue  agent  are  often  satisfied  through  the  medium  of  new 
loans  contracted  through  the  banks.  The  scope  of  the  annual 
obligations  of  governments,  as  of  individuals,  must  be  brought 
within  the  limits  within  which  solvency  may  be  preserved.  The 
patriotic  willingness  of  the  citizen  to  pay  taxes  must  not  be  put 
to  too  severe  a  test  lest  he  be  obliged  to  lower  too  intensely  and 
too  rapidly  his  accustomed  standard  of  living  and  become  ulti- 
mately a  liability  to  the  community  instead  of  an  asset. 

Some  European  governments  find  it  difficult  or  impossible 
to  balance  their  budgets  and  consolidate  their  finances  at  the 
present  moment  pending  the  fixation  and  collection  of  the  re- 
parations which  will  adequately  compensate  the  allied  nations, 
notably  France,  for  the  damage  wrought  in  their  territories. 


No.  17 


^  ts*  CO 


S  i  I  I  I  I  i  8  I  I 


The  British  Merchandise  Balance 


BALANCE  (net)  of  imports  and  exports  of  merchandise  be- 
tween the  United  Kingdom  and  the  rest  of  the  world  annually  in 
£1,000,000. 

No  1813  figure,  since  records  destroyed  by  fire;  1815,  two 
figures  due  to  change  of  fiscal  year. 

For  further  comment  on  this  chart  see  page  116. 

[77] 


78  The  Foreign  Exchange  Problem 

This  uncertainty   rests  heavily   upon   international   trade   and 
finance. 

Private  Economy 

Restrictions  should  be  imposed  upon  the  capital  demands  of 
the  individual  business  enterprises  abroad  in  the  form  of  dis- 
crimination as  to  the  credit  granted,  or  by  adjustment  of  the 
interest  rates,  in  so  far  as  these  requirements  are  not  conducive 
to  the  employment  of  the  productive  forces  of  tlie  community  in 
industries  producing  actual  wealth  in  the  form  of  new  goods. 
A  high  rate  of  interest  will  not,  under  all  circumstances,  as  the 
business  man  more  or  less  instinctively  feels,  curtail  essential 
production.  A  high  rate  of  interest  directs  the  use  of  capital  or 
credit  into  those  channels  where  both  capital  and  credit  will  find 
the  most  immediate  and  most  needed  employment. 

The  production  of  non-essentials  needs  to  be  checked,  and  the 
supply  of  money  in  the  form  of  credit  restricted  by  provident 
reserve  requirements  and  by  immovable  limits  as  to  note  issues. 
The  hmited  supply  of  capital  must  not  be  tied  up  in  enter- 
prises which  though  entirely  safe  and  solvent  will  not  be  actual 
producers  in  the  near  future.  All  the  productive  energies  should 
be  directed  toward  such  constructive  activities  as  promise  to  give 
quick  and  regular  returns  in  the  form  of  necessary  commodities 
or  products. 

Cessation  of  government  inflation  involving  the  stopping  of 
the  continuous  manufacture  of  fiat  money  in  its  various  forms, 
and  a  discerning  distribution  of  commercial  credit  will  free  inter- 
national trade  from  the  prohibitive  risk  which  is  inherent  in  the 
abnormal  fluctuations  of  the  prices  of  merchandise  and  changes 
in  purchasing  power.  It  will  also  prepare  the  ground  for  the 
rehabiUtation  of  confidence  so  necessary  to  attract  foreign  cap- 
ital again  to  the  debilitated  markets  of  Europe. 
Contraction  of  Currency 

Contraction  of  Europe's  inflated  currencies  would  seem  to 
be  possible  only  by  a  reversal  of  the  processes  of  the  war ;  namely, 
by  redeeming  banknotes  and  advances  from  the  central  banks 
with  the  proceeds  of  internal  loans  or  taxes  over  and  above  pres- 
ent expenditures.  Such  a  policy,  however,  to  succeed,  must  take 
care  that  the  loans,  the  levies  of  capital,  and  the  taxes  are  pro- 


Factors  which  will  Stabilize  or  Raise  the  Foreign  Exchanges     79 

portionate  to  the  liquid  wealth  and  the  annual  income  of  the 
citizens ;  that  they  are  not  so  oppressive  as  to  drive  the  citizens 
to  the  banks  for  accommodation.  All  the  instrumentalities  of  the 
financial  markets  should  be  used  cautiously  toward  that  end. 
Cautiously,  because  deflation,  just  as  inflation,  if  it  exceeds  cer- 
tain limits  may  have  the  most  serious  effects  on  the  economic 
progress  of  a  country.  Too  rapid  and  too  extensive  deflation 
are  equally  liable  to  disrupt  trade  and  credit  and  to  react,  during 
a  period  at  least,  against  those  countries  applying  too  radically 
this  cure.  Moreover,  allowance  must  be  made  for  the  fact  that 
all  countries  need  today  much  greater  quantities  of  circulating 
media;  prices  of  merchandise  have  risen,  the  volume  of  business 
in  general  has  increased,  and  finally,  in  certain  countries  the 
hoarding  or  exportation  of  currency  justify  a  larger  circulation. 
It  is  quite  apparent  that  the  purchasing  power  of  the  various 
countries  cannot  rise  during  a  prolonged  period  of  falling 
prices  and  general  depression  which  is  always  followed  by  re- 
duced production  and  by  a  decline  of  national  wealth. 

One  disadvantage  of  deflation  for  the  European  governments 
— one  reason  why  they  are  loath  to  adopt  such  a  policy  too  pre- 
cipitately— lies  in  the  fact  that  deflation  is  likely  to  increase 
instead  of  lightening  their  financial  burden.  Deflation  reduces 
their  taxing  power ;  it  results  in  smaller  incomes. 

Resumption  of  Gold  Payments  by  Deflation 

Theoretically,  deflation  to  a  point  where  gold  payments  may 
be  resumed  appears  possible  only  in  the  case  of  Great  Britain, 
where  both  the  "gold  discount"  and  the  actual  depreciation  are 
relatively  small.^^  This  presupposes,  of  course,  that  to  reach  the 
former  gold  par  there  be  a  deliberate  pohcy  and  willingness  to 
incur  the  sacrifices  involved  in  submitting  to  substantially  re- 
duced expenditures,  adequate  bank  rates,  and,  if  necessary,  re- 
duction of  imports  which  would  have  to  be  paid  again  in  gold, 

{^)  It  may  be  of  value  to  comment  shortly  upon  the  gold  premium  which 
has  appeared  in  Great  Britain  and  has  been  used  from  time  to  time  as  an 
index  of  the  depreciation  of  the  pound  sterling.  It  has  been  endeavored  to 
establish  the  extent,  if  any,  to  which  the  dollar  will  buy  more  merchandise 
in  England  than  in  the  United  States,  by  comparing  the  gold  premium  in 
England  with  the  discount  on  the  pound  sterling  in  New  York.  Upon 
examination,  this  comparison  is  obviously  not  accurate  because  the  amount 
of  gold  offered  in  the  London  open  market  is  insignificant  compared  with 
the  amount  of  indebtedness  to  be  settled.     Therefore,  the  owners  of  the 


80  The  Foreign  Exchange  Problem 

if  not  covered  bj  other  foreign  revenues.  In  other  countries  it 
would  today  appear  to  be  almost  impossible  to  deflate  the  paper 
currencies  to  the  pre-war  gold  pars  by  means  of  contracting  the 
total  quantity  of  circulating  media  without  spoliating  the  legal 
rights  of  the  individual  holder  as  expressed  in  the  face  amount 
of  his  bills  or  notes. 

Inflation  by  the  United  States 

The  converse  method  of  having  tlie  United  States  inflate  its 
currency  would  raise  the  prices  of  merchandise  here.  Conse- 
quently, not  only  the  foreign  exchange  rates  but  also  the  foreign 
securities  bought  here  and  payable  in  foreign  currencies,  would 
increase  in  value  just  as  if  Europe  had  brought  about  by  defla- 
tion a  fall  in  her  merchandise  prices  and  a  decline  in  the  pre- 
mium quoted  on  the  dollar  abroad.  It  would  make  it  easier  for 
Europe  to  pay  its  debts  to  the  United  States.  But  our  investors 
and  our  government  would  get  less  in  terms  of  merchandise  for 
the  original  capital  placed  in  foreign  securities  payable  in  dol- 
lars. To  be  more  explicit,  in  order  to  repay  us  the  fifteen  bilHon 
dollars  borrowed  from  us,  our  debtors  would  have  to  ship  us 
much  less  goods  than  we  shipped  them  when  these  loans  were 
granted.  In  other  words,  Europe  received  from  us  originally, 
for  these  fifteen  billion  dollars,  more  goods  than  we  would  receive 
and  accept  from  her  in  full  payment.  It  would  virtually  amount 
to  cancelling  a  part  of  Europe's  debts,  and  it  has  the  large 
objection  that  inflation  here  would  falsely  stimulate  the  con- 
sumption and  production  in  our  own  country  and  throw  out  of 
gear  the  equilibrium  between  them;  it  would  not  be  a  salutary 
blood  transfusion,  but  only  a  bleeding  which  in  the  end  would 
render  our  economic  position  more  nearly  like  that  of  our  debtors. 

Cancellation  or  Repudiation 

Another  method  by  which  the  exchanges  might  perhaps  be 
restored  to  their  former  parities  has  come  prominently  before 

new  output  of  gold  obtain  for  it  not  only  the  premium  due  to  its  greater 
purchasing  power,  as  expressed  in  paper  money,  but  a  price  above  that 
according  to  the  actual  depreciation  which  this  paper  money  has  suflFered 
in  foreign  markets  beyond  its  real  purchasing  power.  In  fact,  the  gold 
premium  fluctuates  closely  with  the  exchange.  The  volume  of  exchange 
transactions  in  paper  is  so  much  larger  than  the  volume  of  gold  dealings. 
Therefore,  it  may  be  safely  stated  that  the  gold  premium  will  follow  the 
exchange  discount  and  not  vice  versa. 


No.  18 


ts® 


Q       5 


^§3§§§Ss9'?^ 


Public  Debt 

(1)  Public  debt  of  Great  Britain  annually  in  £10,000,000.  Total  of 
funded  debt.  From  1855  on,  the  total  of  funded,  unfunded,  and  terminable 
annuities;  no  unfunded  or  terminable  annuities  existed  prior  to  that  time. 

Insert  reduced  to  1/30  of  main  scale. 

(2)  Public  debt  of  France  in  1,000,000,000  francs.  The  funded  public 
debt  of  France  alone  up  to  1885;  from  then  on  funded  R.  R.  and  other 
debt  has  been  added.    Annual  figures  from  1890  only. 

No  figures  available  for  1870,  1915,  and  1916. 
Insert  reduced  to  1/80  of  main  scale. 

For  further  comment  on  this  chart  see  page  116. 

'     [81]   , 


82  The  Foreign  Exchange  Problem 

the  public  in  recent  discussions ;  viz.,  the  possible  repudiation  or 
cancellation,  on  the  part  of  Europe,  in  some  form  or  other,  of 
her  internal  loans  and/or  the  suspension  of  interest  payments 
on  such  internal  bonds. 

The  cancellation  of  some  of  the  external  loans  by  the  foreign 
creditors  would  represent  either  a  compensation  for  services 
rendered  or  a  gift,  but  not  a  repudiation  on  the  part  of  the  bor- 
rower. The  annual  balance  of  indebtedness  of  the  debtor  country 
would  be  improved,  while  in  the  case  of  repudiation  of  an  in- 
ternal loan,  this  balance  would  not  be  directly  affected. 

Repudiation  will  also  result  from  the  cancellation  or  com- 
plete depreciation  of  all  or  part  of  the  fiat  banknotes  issued 
by  governments  or  governmental  agencies.  In  the  last  two 
hundred  years,  such  a  collapse  in  value  has  occurred  in  a  number 
of  instances,  for  example:  In  1720  in  France  (the  South  Sea 
Bubble  under  Law)  ;  in  1777  in  the  United  States  (Continental 
bills);  in  1796  in  France  (assignats)  ;  in  1811  in  Colombia; 
in  1822  and  1875  in  Peru;  in  1846  in  Portugal;  during  the 
Civil  War  in  the  United  States  (Confederate  notes  in  the 
South) ;  in  1865  in  Uruguay,  and  also  temporarily  in  Austria- 
Hungary,  Greece,  Italy,  and  Russia. 

Currency  Reforms 

As  regards  currency  reforms,  there  are  different  ways  of 
achieving  them.  First,  the  face  amount  of  paper  money  may  be 
reduced  to  a  lower  face  value.  Such  a  reduction  which  would  be 
tantamount  to  composition  with  the  creditors  (holders  of  the 
notes),  will  not  affect  in  the  least  the  foreign  exchange  rates  of 
the  countries  involved,  except  perhaps  numerically.  The  pur- 
clmsing  power  value  of  the  new  currency,  as  expressed  in  terms 
of  merchandise,  will  be  unchanged.  In  enacting  such  reforms, 
it  will,  of  course,  be  necessary  at  the  same  time  to  write  down  all 
the  deposits  on  the  books  of  the  banks,  all  outstanding  internal 
bonds  and  legal  instruments  of  payment,  all  domestic  contracts 
and  obligations  of  whatever  nature  (public  or  private)  on  the 
same  scale,  only  excluding  foreign  obligations  payable  in  gold 
or  foreign  currencies. 

In  order  to  re-establish  a  gold  parity,  there  are  two  possible 
methods :    First,  the  outstanding  banknotes  are  converted  at  a 


Factors  which  will  Stabilise  or  Raise  the  Foreign  Exchanges     83 

certain  ratio  into  money  of  a  lower  denomination,  payable  in 
gold  at  the  former  par;  second,  all  the  banknotes  in  circulation 
on  a  certain  date  will  be  redeemable  in  gold  at  a  smaller  ratio 
than  the  one  in  force  to  date  in  all  gold  standard  countries. 
Such  currency  reforms  have  been  undertaken  in  the  past  by  the 
Argentine  Republic  and  Brazil.  The  temporary  effect  of  either 
of  these  two  measures  on  the  foreign  exchanges  will  depend  on 
the  ratio  adopted  for  the  writing  down  of  the  face  value  of  the 
banknotes  or  the  reduction  of  the  gold  contents  of  the  currency 
unit.  If  the  ratio  is  equal  to  the  "gold  discount"  plus  "under- 
valuation", if  any,  the  foreign  exchange  rate,  other  things  being 
equal,  will  remain  at  its  former  level ;  if  the  ratio  is  to  the  advan- 
tage of  the  holder  of  the  notes,  exchange  will  appreciate,  and 
vice  versa. 

A  scaling  down  of  the  gold  equivalent  of  the  European  cur- 
rencies by  either  of  the  above  methods  would,  however,  not  make 
for  a  permanent  stabilization  of  the  currencies,  if  the  factors 
which  are  responsible  for  the  decline  of  the  exchanges  and  the 
fluctuations  should  continue  to  exercise  their  influence  even  after 
such  a  procedure.  Should  some  of  the  European  countries,  as  a 
consequence  of  a  financial  reorganization  of  this  nature,  resume 
payment  in  gold  (and  in  case  the  balance  of  indebtedness  were 
not  fundamentally  changed  through  economic  measures  tending 
to  aff^ect  the  necessary  equilibrium  between  production  and  con- 
sumption), the  creditor  countries  would  receive  gold  in  payment 
of  annual  balances  and  Europe  would  be  compelled,  sooner  or 
later,  in  view  of  her  limited  gold  reserves,  to  debase  her  cur- 
rencies once  more.  On  the  other  hand,  should  certain  nations 
succeed  in  establishing  and  maintaining  a  relation  between 
their  paper  currencies  and  gold,  they  would  regain  the  advan- 
tage of  having  their  exchanges  stabilized,  the  fluctuations  being 
again,  as  former'ly,  limited  by  the  two  new  gold  points  which 
would  then  automatically  come  into  existence. 

By  difl^erent  processes  of  reasoning  we  have  arrived  at  the 
conclusion  that  while  it  is  indispensable  that  inflation  should  be 
stopped,  it  is  desirable  that  the  execution  of  the  necessary  policy 
of  deflation  be  pursued  with  caution  so  that  the  whole  economic 
system  of  the  countries  involved  be  not  unduly  disturbed. 


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Public  Debt 

1.  United  States:    Public  debt  of  the  United  States,  less  cash 
in  the  Treasury  annually  in  $100,000,000. 

Insert  reduced  to  1/60  of  main  scale. 

2.  Germany:     Sum  of  the  interest  bearing  and  non-interest 
bearing  debt  at  the  end  of  every  year  in  1,000,000,000  marks. 

Insert  reduced  to  1/60  of  main  scale. 

For  further  comment  on  this  chart  see  'page  116. 
[84] 


VII. 

The  Foreign  Exchange  Outlook 


Foreign  bills  of  exchange,  during  a  given  period  of  time,  may 
rise  or  fall  in  value;  however,  as  long  as  the  normal  course  of 
foreign  trade  is  not  interfered  with,  their  quotation  can  never 
permanently  rise  above  or  permanently  fall  below  the  level  which 
is  indicated  by  their  real  value  in  terms  of  gold  or  goods  for 
which  they  are  delivered  as  a  temporary  substitute. 

The  decline  of  the  foreign  exchanges  is  the  logical  outcome 
of  the  unprecedented  upheavals  of  the  last  six  years.  No  reme- 
dies except  those  which  go  to  the  seat  of  the  trouble  will  cure 
our  present  ills.  Observers,  who  have  but  a  superficial  knowl- 
edge of  the  causes  and  the  underlying  circumstances  of  the 
present  situation  and  of  the  conflicting  nature  of  the  influ- 
ences at  work,  still  propound  questions  regarding  the  prob- 
able course  of  the  exchange  markets  in  the  immediate  future, 
and  are  inclined  to  imagine  that  an  expeditious  and  universal 
panacea  can  readily  be  found  and  applied.  It  is  difficult  indeed 
for  the  outsider  to  appreciate  the  obstacles  that  stand  in  the  way 
of  an  attempt  to  interpret  correctly  the  successive  and  numerous 
trends  of  the  exchanges  ever  since  the  signing  of  the  armistice. 
Contradictory  as  they  appear  to  the  layman,  it  must  be  ac- 
knowledged that  they  are  often  no  less  perplexing  to  the  profes- 
sional. The  futility  of  forecasts  in  this  field  has  been  so  profusely 
demonstrated  in  the  past  that  today  we  must  be  wary  and  cau- 
tious in  expressing  definite  opinions.  Fundamental  improve- 
ments and  deep-rooted  changes  will  have  to  be  made  in  the  eco- 
nomic and  financial  policies  of  the  nations.  The  present  dis- 
turbed conditions  are  the  result  of  a  long  period  crowded  with 
the  most  revolutionizing  events  in  the  world's  history,  and  the 
recovery  from  the  setback  which  followed  in  their  wake  will,  at 
best,  be  a  gradual,  if  not  long  drawn-out  process. 

[85] 


86  The  Foreign  Exchange  Problem 

In  1830,  Baron  Louis,  the  Minister  of  Finance  of  Louis- 
Philippe,  King  of  France,  told  the  assembled  Cabinet:  "Give 
me  a  sound  national  policy  and  I  shall  give  you  sound  national 
finances!"  Forgotten  though  they  seem  to  be,  these  words  ex- 
press in  the  simplest  form  what  is  wanted  today :  Sound  prin- 
ciples, sound  institutions,  and  sound  judgment.  A  definite  work- 
iible  program  must  be  put  forth  and  carried  into  effect  for  the 
adjustment  of  the  political  differences  still  existing  abroad.  The 
unreserved  co-operation  of  the  European  peoples  must  be  secured 
for  the  sincere  enforcement  of  these  primary  reforms :  "Restora- 
tion of  order  in  public  finances,  purging  of  currencies,  and  free- 
dom of  commercial  transactions."  (Brussels  Financial  Con- 
ference, Report  of  the  Committee  on  International  Credits.) 
Then,  if,  under  the  effective  surveillance  of  the  lenders,  rational 
distribution  by  responsible  governments  or  representative  public 
bodies  can  be  secured,  the  exportation  of  the  required  raw 
materials,  commodities,  and  products  may  be  financed  to  the  full- 
est desirable  extent  by  way  of  long  term  investments  or  credits. 
The  disturbed  relationship  between  production  and  consumption 
will  be  corrected.  The  debtors,  after  having  covered  their  own 
elementary  internal  needs,  will  be  able  to  provide  for  the  payment 
of  the  interest  and  moderate  funding  charges  on  their  external 
loans.  The  annual  accounts  with  their  foreign  creditors  will 
again  be  balanced.  The  value  of  their  monies  and  obligations 
will  no  longer  depreciate.  The  decline  of  the  exchanges  will 
come  to  a  natural  halt. 

Failing  such  positive  action  the  purchases  of  merchandise 
by  Europe,  and  for  that  matter,  also  by  a  number  of  our  other 
foreign  customers,  will  be  considerably  reduced,  to  the  great 
detriment  of  our  domestic  economy.  The  supply  of  exchange  will 
continue  on  a  steadily  increasing  scale  and  an  adequate  demand 
will  not  come  forth.  The  downward  tendency,  especially  if  it  is 
reinforced,  as  it  probably  will  be,  by  continued  inflation  in  Eu- 
rope, is  bound  to  make  further  progress,  all  ephemeral  recoveries 
notwithstanding. 

The  nature  of  our  trade  and  financial  relationship  with  for- 
eign countries,  and  especially  with  those  of  Europe,  has  changed 
since  1914  in  such  a  manner  that  we  can  no  longer  view  with 


The  Foreign  Exchange  Outlook  87 

equanimity  this  latter  eventuality.  Nevertheless,  there  would 
not  appear  to  be  any  ground  for  undue  apprehension.  The 
course  of  events  will  probably  in  no  small  measure  depend  on 
the  discerning  use  which  we  shall  make  in  the  immediate  future 
of  our  influence  and  credit  which  have  never  before  stood  so  high 
in  the  world.  By  a  strange  reversal  of  history,  the  events  which 
have  brought  about  the  impairment  of  the  finances  of  the  na- 
tions arrayed  in  or  affected  by  the  World  War,  have  placed  our 
country  in  a  very  favorable  strategic  position  which  has  not 
been  altered,  to  any  considerable  extent,  by  the  depression  that 
has  marked  the  last  half  of  1920  and  from  which  we  are  just 
emerging. 

Precious  lives  and  property  have  been  destroyed,  but  in  many 
countries  appreciable  progress  has  already  been  made  toward 
normality.  The  human  ingenuity  and  fundamental  forces  which 
in  the  past  have  put  capital  to  fertile  use  are  not  obliterated. 
These  superior  qualities  and  remarkable  characteristics  have  been 
among  the  essential  elements  in  the  prosperity  of  the  old  hemis- 
phere in  the  days  when  it  enabled  other  countries  to  develop 
their  natural  riches  and  work  out  their  own  destiny  by  lending 
them  ready  and  ample  assistance  in  the  form  of  money  and  man- 
power. 

After  the  present  period  of  transition,  unless  all  lessons  of 
the  past  are  to  be  contradicted  by  the  experiences  of  the  future, 
these  latent  powers  and  innate  traits  will  again  come  to  the  fore 
in  the  laboratories  and  workshops  of  Europe.  Then  it  may  be 
confidently  expected  that  efficiency  and  industriousness  will  re- 
vive with  a  vigor,  the  intensity  of  which  can  be  amplified  only 
by  the  urgent  need  and  the  ardent  desire  for  the  quickest  pos- 
sible rehabilitation.  We  may  feel  assured  that,  whether  it  occurs 
in  the  near  future  or  whether  the  patience  and  faith  of  our 
friends  and  associates  abroad  is  to  be  further  tested,  the  move- 
ment of  the  foreign  exchanges  will  accurately  reflect,  and  perhaps 
presage,  the  coming  of  this  era  of  renaissance. 


No.  20 


Gold  Imports  and  Exports  French  Gold  Movements 

Balance  (net)  of  Imports  and  exports  of  gold  between  France  and  tbe  rest 
of  the  world,  annually  in  $1,000,000. 

_ — .  Balance  of  gold  and  silver  imports  and  exports. 

1920  figure  7  months  only. 

No.  21 


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Gold  Movements  Between  United  States  and  France 

BALANCE  of  imports  and  exports  of  gold  between  the  United  States  and 
France  annually  in  $1,000,000. 

Figures  for  exports  from  the  United  States  include  domestic  and  foreign 
exports. 

For  further  comment  on  this  chart  see  page  118. 

[88] 


ADDENDA 


Historical  Survey 


Foreign  exchange  history  during  the  past  one  hundred  and 
thirty  years  reveals  three  periods  of  major  disturbances:  first, 
the  French  Revolution  and  the  Napoleonic  Wars;  second,  the 
Civil  War ;  and  third,  the  Great  War.  We  propose  to  compare 
briefly  the  outstanding  economic  features  of  the  first  two  periods 
with  those  surrounding  the  recent  World  Conflagration. 

Civil  War 
Exchange 

We  find  certain  striking  parallels  in  comparing  conditions 
during  the  Civil  War  with  those  whicl^  prevailed  lately.  The 
leading  countries  of  Europe  were  then  on  a  metallic  standard, 
while  the  United  States  had  a  depreciated  paper  currency. 
Today  our  country  is  on  a  gold  basis,  whereas  Europe,  as  a 
whole,  has  departed  from  the  gold  standard.  Beginning  with 
I860,  the  foreign  exchanges  went  against  the  United  States,  fluc- 
tuating to  about  the  same  extent  as  did  the  gold  premium,  which 
in  its  turn  reflected  more  or  less  accurately  the  depreciation  of 
our  paper  currency. 

Deflation 

After  1865  the  world  entered  upon  a  period  of  declining 
gold  production  which  lasted  until  1891.  This  factor,  in  the 
face  of  increased  population  and  movable  wealth,  made  for 
lower  merchandise  prices  (that  is  to  say,  for  a  higher  value  of 
gold).  The  same  problem  of  enforced  and  almost  automatic 
deflation  of  prices,  caused  by  a  supply  of  gold  which  does  not 
keep  pace  with  the  increasing  production  of  goods,  is  likely  to 
face  the  world  again  during  the  years  to  come,  according  as  it  is 
able  to,  and  does  go  back  to  the  gold  standard.  Even  if  but 
few  countries  remain  on  a  gold  basis,   and  if,  owing  to  the 

[89] 


90  The  Foreign  Exchange  Problem 

enlarged  production  of  goods,  the  annual  gold  production  is  less 
than  the  increase  of  the  annual  demand  for  gold,  the  effect  of 
such  deflation  is  bound  to  be  felt  not  only  by  the  gold  standard 
countries  but  also  by  all  other  countries,  through  the  action  of 
the  foreign  exchanges  on  the  price  levels  (providing  such  action 
can  make  itself  felt  as  a  result  of  the  restoration  of  free 
commerce). 

Economic  Conditions 

The  economic  conditions  during  the  Civil  War  were  funda- 
mentally different  from  those  which  prevailed  during  the  recent 
world  struggle.  Half  a  century  ago  our  country  had  a  great 
wealth  of  unexploited  resources;  government  expenditures  were 
quickly  reduced  and  inflation  stopped.  None  of  these  things 
is  true  of  the  Europe  of  today.  In  the  seventies,  European 
capital  sought  American  investments  in  order  to  employ  her 
surplus  savings;  labor  was  not  extensively  organized.  Wages, 
therefore,  could  be  more  rapidly  adjusted  to  meet  the  drop  in 
prices  than  seems  possible  today,  either  here  or  in  Europe. 
Moreover,  the  productive  capacity  of  the  various  countries  was 
vastly  raised  by  numerous  and  epoch-making  inventions.  Our 
country  soon  assumed  the  first  rank  among  the  agricultural 
producers  and  the  exporting  nations.  Unless  new  and  startling 
inventions  come  to  light  hereafter,  it  does  not  seem  probable  that 
Europe,  after  the  recent  war,  will  go  through  a  similar  evolution. 

The  Napoleonic  Wars 
Economic  Conditions 

The  general  economic  situation  after  the  Napoleonic  Wars 
shows  rather  more  analogies  to  the  present  conditions  than  those 
witnessed  after  the  Civil  War.  The  Civil  War,  despite  its  mag- 
nitude and  the  destruction  wrought,  especially  in  the  South,  was 
after  all  but  a  local  struggle.  The  Napoleonic  wars,  if  the  war 
of  181S  is  included,  were  truly  world  wars.  The  hostilities  were 
long  and  strenuous;  the  loss  of  lives  and  property  immense; 
embargoes,  inflations,  gold  premiums,  blockades,  subsidies,  in- 
demnities, price  fixing,  were  witnessed,  just  as  during  the  recent 
war. 


Addenda  91 

Exchange 

The  pound  sterling  declined  during  the  French  Revolution 
and  the  Napoleonic  wars  up  to  the  outbreak  of  hostilities  be- 
tween our  country  and  Great  Britain.  Fluctuations  followed 
closely  the  gold  premium  quoted  in  England  beginning  with 
1797.  In  1814,  as  the  climax  of  a  period  of  wild-cat  banking 
which  had  begun  in  1802,  gold  premiums  appeared  also  in  dif- 
ferent parts  of  our  own  country.  With  a  premium  on  gold  pre- 
vailing in  Great  Britain  and  a  similar  premium  paid  in  the  United 
States,  sterling  exchange  here  sought  a  balance  between  them. 
For  example,  as  paper  currency  depreciated  in  Baltimore^^ — the 
premium  on  the  gold  dollar  rose — those  merchants  doing  busi- 
ness in  Baltimore  had  to  pay  more  paper  dollars  for  the  paper 
pound  sterling,  but  this  premium  on  the  paper  pound  would 
again  be  reduced  as  soon  as  the  quotations  from  London  re- 
flected a  rise  of  the  premium  on  the  gold  pound  in  Great  Britain. 

Trade 

As  has  been  the  case  after  the  recent  struggle,  a  post-war 
boom  took  place  in  Great  Britain  in  1814-1815.  She  had  pro- 
duced large  stocks  of  goods  to  meet  expected  demands  after  the 
restoration  of  peace.  However,  it  soon  became  evident  that  the 
world,  and  Europe  especially,  could  not  assimilate  all  the  mer- 
chandise that  was  thrown  on  the  markets ;  besides,  foreign  com- 
petition was  encountered  when  the  seas  were  again  opened  to 
trade.  By  the  introduction  of  the  factory  system  at  that  time, 
the  United  Kingdom  was  able  to  produce  more  and  more,  while 
Europe  consumed  less  and  less  for  lack  of  funds  caused  by  finan- 
cial exhaustion.  This  situation  was  aggravated  by  a  series  of 
poor  crops  all  over  Europe.  A  crisis  in  Great  Britain  in  1815 
and  another  of  short  duration  in  1818  were  the  result.  Our 
country,  too,  experienced  a  setback  between  1819  and  1822. 
This  development  resembles  the  slump  in  trade  and  the  strin- 
gency of  credit  conditions  which  took  place  during  the  second 
half  of  1920. 

C"")  See  Chart  No.  30,  page  110. 


92  The  Foreign  Exchange  Problem 

Prices 

Prices  rose  during  the  Civil  and  the  Napoleonic  Wars,  not 
so  much  because  of  a  shortened  supply  of  goods,  but  because  of 
inflation.  As  the  inflation  was  curbed  and  production  relatively 
increased,  prices  returned  to  their  previous  levels. 

Taxation 

Figures  on  national  income  are  not  available  for  the  early 
part  of  the  last  century.  It  is,  therefore,  impossible  to  deter- 
mine whether  taxation  today  is  more  or  less  burdensome  than  it 
was  then.  It  may,  however,  safely  be  stated  that,  even  allowing 
for  changes  in  price  levels,  the  individual  taxpayer  today  pays 
higher  taxes,  and  by  virtue  of  his  higher  income  is  better  able 
to  bear  them. 

Interest  Rates 

Interest  rates  rose  during  all  wars  with  increasing  demand 
for  capital,  and  gradually  receded  as  the  need  for  it  was  no 
longer  pressing.  This  is  but  partially  reflected  in  the  rates  of 
the  central  banks,  due  to  the  fact  that,  just  as  during  the  last 
six  years,  they  maintained  their  discount  rates  below  those  war- 
ranted by  the  scarcity  of  capital. 

Summarizing,  prices  of  goods,  taxes,  and  interest  rates  ex- 
perienced a  more  or  less  sharp  rise  during  all  the  wars  which  we 
have  discussed,  and  were  followed  by  a  less  rapid  fall  in  the  years 
immediately  after  the  restoration  of  peace.  Although  some  of 
these  phenomena  may  bear  a  close  resemblance  to  those  noted 
during  the  World  War,  it  is  not  safe  to  assume  that  this  sim- 
ilarity will  also  extend  into  the  future  to  all  other  related 
factors. 

We  must  not  forget  that  the  background  and  the  basic  con- 
ditions which  have  confronted  the  world  ever  since  the  armistice 
are  radically  different.  During  and  after  the  Napoleonic  Wars, 
and  even  after  the  Civil  War,  the  world  was  still  essentially 
agricultural.  In  1815,  England  alone  had  introduced  the  indus- 
trial system,  and  for  this  reason  also  suffered  temporarily  more 
than  the  other  belligerents.     The  various  countries  were  largely 


Addenda  98 

self-sufficient  and,  in  periods  of  depression,  thej  always  had  the 
refuge  of  releasing  part  of  their  surplus  consumers  through  emi- 
gration to  virgin  or  undeveloped  continents.  Our  own  country 
possessed  enormous  untapped  resources,  and  its  population  was 
smaller.  Credit  had  barely  been  developed.  Foreign  trade, 
compared  with  domestic  trade,  was  still  in  its  infancy.  Lending 
to  foreign  countries  was  chiefly  the  domain  of  Great  Britain. 
Interest  charges  were  relatively  unimportant  in  the  balance  of 
payments. 

In  short,  although  the  problems  to  be  solved  are  the  same 
today  as  they  were  fifty-five,  and  one  hundred  years  ago — 
destruction  of  property,  depreciated  currency,  inflated  prices, 
and  dislocated  commercial  relationships — the  economic  situation 
of  the  various  countries  is  so  different  that  no  analogies  may 
safely  be  drawn  without  almost  nullifying  qualifications.  It  is 
true  that  the  possibilities  for  improvements  and  more  rapid  re- 
covery than  took  place  after  previous  wars  seem  to  be  so  much 
greater  today,  because  of  the  vastly  larger  potential  productive 
capacity  and  the  progress  made  since  then  in  all  fields  of  human 
endeavor.  On  the  other  hand,  the  interdependence  of  all  coun- 
tries and  continents  has  also  increased  to  no  small  extent,  and 
disease  or  decay  in  some  parts  of  the  body  politic  are  more  likely 
to  delay  the  recuperation  of  the  whole. 


NOTE  ON  THE  CHARTS 

We  have  been  obliged  to  restrict  our  research  to  the  United 
States,  Great  Britain,  France,  and  Germany,  as  we  have  been 
unable  to  obtain  for  other  countries  the  necessary  data  running 
back,  more  or  less  continuously,  into  the  early  part  of  the  19th 
century. 

Certain  charts  have  inserts.  Volume  of  trade,  size  of  govern- 
ment debts,  amount  of  money  in  circulation,  etc.,  have  all  increased 
so  tremendously  that,  in  order  to  preserve  the  fluctuations  witnessed 
in  the  early  part  of  the  last  century,  it  has  been  found  necessary 
to  break  the  graph  in  many  cases,  after  the  beginning  of  the  World 
War.  The  graph  has  then  been  continued  in  the  insert  on  a  very 
much  reduced  scale.  This  reduction  is  indicated  opposite  every 
chart. 

All  the  charts  showing  the  balance  of  trade,  or  merchandise,  or 
gold,  have  a  heavy  black  line,  which  is  marked  zero.  This  may  be 
explained  by  one  example:  In  chart  No.  1  entitled  The  Visible 
Trade  Balance  of  the  United  States;  whenever  the  graph  is  above 
the  zero  line,  it  shows  that  the  sum  total  of  all  the  exports  of  the 
United  States  to  the  rest  of  the  world  has  exceeded  the  total  imports 
of  the  United  States  from  the  rest  of  the  world,  by  an  amount  in- 
dicated by  the  distance  of  the  graph  from  the  zero  line. 

In  1918,  the  U.  S.  Bureau  of  Foreign  and  Domestic  Commerce 
changed  its  fiscal  year  from  July- June  to  January-December; 
therefore,  in  all  those  charts  showing  movements  of  goods  and  mer- 
chandise involving  the  United  States,  two  figures  have  been  given 
for  1918;  the  first  being  the  figure  for  the  fiscal  year  ending  June 
30,  1918,  and  the  second,  the  figure  for  the  fiscal  year  ending 
December  31,  1918;  there  is  thus  an  overlap  of  6  months  in  the 
two  figures  quoted. 

The  historical  data  describing  certain  of  the  charts  has  been 
divided  into  two  columns,  one  referring  to  the  high  points  and  the 
other  the  low  points  of  the  grapb. 

[94] 


No.  22 


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British  Gold  Movements 
BALANCE    (net)    of  imports   and  exports   of  gold  between 
Great  Britain  and  the  rest  of  the  world  annually  in  £100,000.     No 
1917  figures  available;   1919  figures  for  the  last  6  months  of  the 
year  only;  1920  figures  for  11  months  only. 

[95] 


No.  28 


^   M   3   ^   § 

^   ^  ?9   ^  ^ 

GOLD  IMPORTS  AND  EXPORTS 

For  f further  comment  on  this  chart  tee  page  118. 


[96] 


Gold  Imports  and  Exports 

(1)  Balance  (net)  of  gold  imports  and  exports 
between  the  United  States  and  Great  Britain,  an- 
nually in  $1,000,000. 

(2)  Balance  (net)  of  gold  imports  and  exports 
between  the  United  States  and  Germany,  annually 
in  $1,000,000. 

Export  figures  are  sum  of  foreign  and  domestic 
exports.  Since  imports  and  exports  of  gold  and 
silver  are  not  separable,  1821-1824,  the  figures 
used  for  those  years  are  the  net  balances  of  gold 
and  silver  imports  and  exports  together. 

Export  figure  for  1863  contains  domestic  export 
of  silver. 

The  1920  figure  of  Great  Britain  ($274,883,- 
397)  is  so  large,  due  to  the  transfer  from  the 
Bank  of  England  of  gold  which  already  belonged 
to  the  United  States,  but  had  merely  not  been 
shipped.     (See  comment  on  chart  No.  3.) 


[97] 


No.  24 


UNITED    STATES    GOVERNMENT    SECURITY    QUOTATIONS 


[98] 


United  States  Government  Security 
Quotations 

Annual  high  and  low  quotation  in  New  York 
and  Boston: 

United  States  3%  paid  in  1833,  Boston. 

No  government  bonds  outstanding  1834-1842. 

United  States  6%  of  1862,  1842-1849,  Boston. 

United  States  6%  of  1868,  1860-1861,  Boston. 

United  States  1881  coupon  6%,  1861-1879,  New 
York. 

United  States  1907  coupon  4%,  1877-1907,  New 
York. 

United  States  1925  coupon  4%,  1906-1918,  New 
York. 

United  States  1st  Liberty  4%  1932-1947,  1917- 

(On  account  of  the  varying  and  short  maturi- 
ties, it  was  found  impossible  to  convert  all  the 
bonds  to  a  uniform  %  basis  to  make  a  useful  curve ; 
such  a  computation  does  not  result  in  a  continuous 
curve  of  quotations.) 

Stock  Exchange  closed  July  31st  to  Nov.  17th, 
1914,  both  inclusive. 


1812-15     War  of  1812. 
1814-17     Currency  disorders  in  U.  S. 
1848     Expedition  against  Mexico. 
1860     Outbreak  of  the  Civil  War. 

1877-78     Strikes   and  depression  in  the 
United  States. 

1893     Crisis  in  the  United  States. 


[99] 


No.  25 


,^      K.      $      so      29     ^ 


9P      © 


BRITISH    GOVERNMENT    SECURITY    QUOTATIONS 


O         <D        i^         N.  - 

&     ^     ja     aJl     sy 
flg     OQ     ^     ^     &- 


[100] 


British  Government  Security  Quotations 

Annual  high   and  low  quotation   for 


British  consols  in  London. 

Yearly  average  quotation. 

a.  Up  to  April  5th,  1889,  the  rate  of  interest 
was  3% ;  for  the  14  years  ending  April  16th,  1903, 
2}i%;  now  the  rate  is  2>^%. 

b.  The  Stock  Exchange  was  closed  July  30th, 
1914  to  the  end  of  the  year. 

c.  Minimum  price  {65)  removed  Nov.  23d,  1916. 


1793 

France  declares  war  on  England. 

1801 

Peace  of  Amiens. 

1816 

Recovery    of    consols    after    downfall    of 

Napoleon. 

1898 

Boer  War. 

1914 

Outbreak  of  Great  War. 

1797 

England  fears  invasion  by  France 
— Inflation  by  the  Bank  of  Eng- 
land. 

1800 

Crisis  in  England. 

1803 

War  breaks  out  once  more  with 
France. 

1810 

Crisis  in  England. 

1815 

Climax  of  struggle  with  Napoleon; 
Crisis. 

1826 

Crisis  in  England. 

1826 

England  fears  war  with  France. 

1831 

Riots  in  England  and  Ireland. 

1847 

Crisis  in  England. 

1854 

Outbreak  of  Crimean  War. 

1866 

Crisis  in  England. 

1870 

Outbreak  of  Franco-Prussian  War. 

1886 

DiflSculties  with  Russia  and  Egypt. 

1890 

Crisis  in  England. 

1907 

World  Crisis. 

[lOlJ 


^^^%H9\^J 


No.  26 


9?       ^       ^      t: 

FRENCH  GOVERNMENT  SECURITY  QUOTATIONS 


[102] 


French  Government  Security  Quotations 

Annual  high  and  low  quotation  in  Paris  on  a 
3%  basis. 

5%  Rente  of  1793;  1798-1829  recomputed  to  a 
3%  basis. 

3%  Rente  perpetuelle  1825- 


1799  Bonaparte  appointed  consul. 

1801  Peace  of  Luneville. 

1807  Treaty  of  Tilsit. 

1818  Congress  of  Aix-la-Chappelle. 

1852  Coup  d'Etat  by  Napoleon  III. 

1856  Peace  of  Paris  in  Crimean  War. 

1813-15     Downfall  of  Napoleon. 

1830-32  Political  Revolution  in  France 
and  elsewhere. 

1840  Anglo-French  dispute;  London 
conference  over  Egypt  and  Tur- 
key. 

1848  Political  disturbances  in  France 
and  elsewhere. 

1854     Crimean  War. 

1859  Franco  -  Austrian  War  against 
Italy. 

1866     Austro-Prussian  War. 

1870-1     Franco-Prussian  War. 

1883     Madagascar  incident. 

1887  War  between  Germany  and  France 
imminent. 

1914     Outbreak  of  Great  War. 


[103] 


No.  27 


GERMAN    GOVERNMENT    SECURITY    QUOTATIONS 


[104] 


German  Government  Security  Quotations 

Annual  high  and  low  quotation  in  Berlin  on  a 
3^%  basis. 

Prussia:  4%  Certificates  of  Indebted- 


ness converted  to  3^6%  basis  in  1842.;  1807-1868. 

Prussia:    4J^%    Bonds    1866-1885; 

quotations  recomputed  to  a  3 J4  %  basis. 

Prussia:     V/2%     Consolidated     Loan 

1866-1900   (fluctuated  identically  with  the  8J^% 
security  of  the  German  Empire). 

Germany:   3J^%    Inconvertible  National  Loan 
1900-1920. 


-Annual  high  and  low  quotation. 


Last  quotation  of  the  year. 

1914  quotations  are  Jan.- July  only;  No  quota- 
tions for  1915  or  1917. 


1815 

End  of 

Napoleonic  Wars. 

1871 

End  of  Franco-Prussian  War. 

1826 

Crisis  in  England,  threat  01  wiu 
between  England  and  France. 

1830 

Revolution  all  over  Europe. 

1848 

Revolution  all  over  Europe. 

1859 

Franco-Italian  War  against  Aus- 
tria. 

1864 

Austro-Prussian  war  against  Den- 
mark. 

1866 

Austro-Prussian  War. 

1870 

Franco-Prussian  War. 

1872 

Crisis  in  Germany. 

1907 

Crisis. 

1914 

Outbreak  of  Great  War. 

[105] 


No.  28 

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<0  00  5; 


GOLD   PREMIUMS 


[106] 


Gold  Premiums 

The  prices  in  paper  paid  for  gold  are  given  on 
a  percentage  basis,  100  signifying  that  gold  and 
paper  were  interchangeable  or  equivalent. 

(1)  London:  High  and  low  quotation  1794- 
1796. 

(2)  London:  Annual  average  of  the  gold  pre- 
mium during  the  suspension  of  specie  payments  by 
the  Bank  of  England  1797-1821. 

(3)  New  York:  Annual  high  and  low  quotations 
of  the  gold  premium  during  the  suspension  of 
specie  payments  in  New  York  1814-1817. 

(4)  New  York:  Annual  high  and  low  quota- 
tions of  the  gold  premium  during  the  suspension  of 
specie  payments  in  the  United  States  1862-1879. 

(5)  London:  Annual  high  and  low  quotations  of 
the  gold  premium  in  London  from  October  1919, 
on. 

1921  figure  to  Feb.  4,  1921. 


1795-7  Currency  disorders  in  England. 

1797-1821     Bank  of   England   suspended   Specie 
Payments. 

1861-1879     United  States  suspends   Specie  Pay- 
ments. 

October,  1919  England  lifts  restrictions  upon 
sale  of  gold  to  the  extent  of  permitting  sales 
of  new  gold  mined  in  her  colonies. 


[107] 


No.  29 


I     I     I     I 


BOSTON  EXCHANGE  ON  LONDON 


[108] 


Boston  Exchange  on  London 

Annual  high  and  low  quotation  of  60- 


days  sight  rates  (the  number  of  dollars  for  the 
pound)  according  to  the  scale  on  the  right; 
$4.44  4/9,  the  gold  par,  is  indicated  by  the  heavy 
black  line. 

No  quotation  1797;  average  quotation  only  for 
1823. 

The  price  paid  for  gold  in  London 

expressed  as  a  %  of  par,  par  being  indicated  by 
the  heavy  line  marked  zero  (read  scale  on  left 
downward).  Annual  high  and  low  quotations 
1794-96;  annual  average  quotations  during  the 
suspension  of  specie  payments  by  the  Bank  of 
England  1797-1821. 

This  chart  shows  the  effect  of  a  depreciation  of 
currency  on  exchange  rates;  England's  currency 
depreciated  (as  witnessed  in  the  rising  gold  pre- 
mium) and  exchange  followed  it.  The  peak  of 
depreciation  was  attained  in  1814.  The  lowest 
point  of  the  exchange,  however,  was  reached  in 
1812.  Exchange  did  not  continue  to  depreciate, 
following  the  currency  depreciation,  because  in 
1812  the  war  with  England  broke  out.  This  fact 
tended  to  pull  the  exchange  in  the  opposite  di- 
rection. 


[109] 


No.  80 


g    I 


BALTIMORE   EXCHANGE    ON    LONDON 


[110] 


Baltimore  Exchange  on  London 

Annual  high  and  low  quotation  of  60 


days  sight  rates  (the  number  of  dollars  for  the 
pound)  according  to  the  scale  on  the  right; 
$4.44  4/9,  the  gold  par,  is  indicated  by  the  heavy 
black  line. 

The  price  paid  for  gold  in  London 

expressed  as  a  %  of  par,  par  being  indicated  by 
the  heavy  line  marked  zero.  (Read  scale  on  left 
downward.)  Annual  high  and  low  quotations 
1794-1796;  annual  average  quotation  during  the 
suspension  of  specie  payments  by  the  Bank  of 
England  1797-1821. 

The  price  paid  for  gold  in  Baltimore 

expressed  as  a  %  of  par,  par  being  indicated  by 
the  heavy  line  marked  zero  (read  scale  on  the  left 
upward).  Annual  high  and  low  quotation  during 
the  suspension  of  specie  payments  in  New  York 
1814-1817. 

Compared  with  chart  showing  Boston  exchange 
on  London  during  this  same  period,  we  have  here 
presented  the  effect  upon  exchange  of  a  depreci- 
ated currency  in  both  of  the  countries  involved. 
Whereas,  New  England  Banks  managed  to  main- 
tain their  bank  notes  on  a  sound  basis,  banks  in 
the  middle  Atlantic  and  Southern  States  were 
forced  to  suspend  specie  payments  so  that  the 
notes  of  these  banks  sold  at  varying  discounts. 
Therefore,  whereas  the  gold  premium  in  England 
tended  to  force  exchange  below  the  gold  parity 
of  $4.44  4-9,  the  presence  of  the  gold  premium  in 
Baltimore  tended  to  pull  exchange  above  this 
figure.  If  it  had  not  been  for  the  war,  (assuming 
the  balance  of  trade  to  have  been  even)  exchange 
may  be  expected  to  have  f.ound  a  balance  exactly 
between  the  two  gold  premiums. 


[Ill] 


Comment  referring  to  Chart  No.  2,  page  4. 

THE   MERCHANDISE  BALANCE   OF   THE 
UNITED  STATES 

Thus,  in  1879,  there  was  a  large  American  crop 
over  against  small  crops  in  France,  Russia  and 
Germany,  while  England  experienced  her  poorest 
harvest  of  the  century,  and  American  exports 
reached  hitherto  unprecedented  levels. 

The  same  situation  occurred  in  1898.  In  1897 
there  had  been  a  scorching  drought  in  France, 
while  wet  harvests  and  storms  reduced  the  crops 
in  Russia  and  the  Danube  valley.  The  American 
farmer,  on  the  other  hand,  gathered  the  largest 
crop,  with  one  exception,  on  record. 

Until  approximately  1875  the  United  States  was 
an  importing  country  and  she  was  able  to  pay  for 
her  excess  of  imports  by  borrowing  on  a  long  term 
basis  from  Europe.  Since  that  time  exports  of 
merchandise  from  the  United  States,  with  two  ex- 
ceptions, exceeded  her  imports.  Our  foreign  trade, 
though  to  a  decreasing  extent  in  recent  years,  has 
been  affected  by  the  crop  situation  all  over  the 
world.  Especially  large  crops  in  the  United  States 
or  crop  failures  in  Europe,  or  both,  have  always 
tremendously  increased  exports  from  the  United 
States  and  thus  also  increased  the  export  balance 
of  the  United  States;  thus  in: 

1882     Europe  produced  largest  crop  on  record; 
U.  S.  crop  fair. 

1891  U.    S.    crop   largest    on   record;    Europe's 
small. 

1892  U.  S.  crop  not  particularly  good  but  sold 
well,  since  European  supplies  low. 

1893  U.  S.  crop  small;  Europe's  large. 

1897  U.  S.  crop  largest  on  record  with  one  ex- 
ception; drought  in  Europe. 

1898  U.  S.  crop  exceeded  all  precedents. 
1902     Good  crop  here. 

1905  Largest  world  crop  on  record. 

1906  World  crop  exceeded  that  of  1905. 


[112] 


Comment   referring    to   Chart  No.   3,   page   9. 

UNITED  STATES  GOLD  MOVEMENTS 

Imports  and  exports  of  gold  to  and  from  the 
United  States  are  largely  connected  with  its  im- 
ports and  exports  of  merchandise.  Usually  when- 
ever exports  of  merchandise  were  large,  imports 
of  gold  also  showed  an  increase.  Thus,  for  ex- 
ample, in: 

See 
Chart 
No. 
1881     U.  S.  merchandise  exports  were  large. .     2 

U.  S.  gold  imports  were  large S 

1881     U.    S.    merchandise    exports    to    Great 

Britain    were    large 11 

U.  S.  gold  imports  from  Great  Britain 

were  large   28 

1893     Exports    of    merchandise   to    Germany 

comparatively  small 14 

Exports  of  gold  to  Germany  compara- 
tively large   23 

1896     U.  S.  exports  of  merchandise  to  Great 

Britain  small 11 

U.  S.  exports  of  gold  to  Great  Britain 

large 23 

1898     U.  S.  merchandise  exports  to  the  world 

large 2 

U.  S.  gold  imports  from  the  world  large     3 
1890     U.   S.   merchandise   exports   to   France 

large 13 

U.  S.  gold  imports  from  France  small. .   21 
1910     U.  S.  merchandise  exports  to  the  rest  of 

the  world  small 2 

U.  S.  gold  exports  to  the  rest  of  the 

world  large   8 

1910     Small    balance    of    exports    to    Great 

Britain   11 

Large  exports  of  gold  to  Great  Britain.   23 


[US] 


Comment  referring  to  Chart  No.  11,  page  63. 

UNITED  STATES  TRADE  WITH  THE 
UNITED  KINGDOM 

1861  Outbreak  of  Civil  War. 

1862  General  European  crop  failure. 

1879  Poorest  harvest  of  century  in  United  King- 
dom; U.  S.  crop  large. 

1882  Europe  produces  largest  crop  on  record; 
U.  S.  crop  fair. 

1891  U.  S.  crop  largest  on  record;  Europe's 
small. 

1892  U.  S.  crop  not  particularly  good,  but  sells 
well  since  European  supplies  low. 

1893  U.  S.  crop  small;  Europe's  large. 
1898  U.  S.  crop  exceeds  all  precedents. 
1911     Short  crop  in  Europe  and  the  U.  S. 


Comment  referring  to  Chart  No.  18,  page  60. 

UNITED  STATES  TRADE  WITH  FRANCE 

1862     General  European  crop  failure. 

1879     Poor  harvests  in  Europe. 

1882  Europe  produces  largest  crop  on  record; 
U.  S.  crop  fair. 

1889  U.  S.  crop  largest  since  1884,  and  all  Eu- 
rope's crop  small. 

1891  Europe  has  poorest  harvest  since  1879; 
U.  S.  crop  largest  on  record. 

1892  U.  S.  not  particularly  good,  but  sells  well 
since  European  supplies  low. 

1893  Rich  harvest  all  over  Europe;  small  crop 
here. 

1898     U.  S.  crop  exceeds  all  precedents. 
1902     Good  crop  here. 


[114] 


Comment  referring   to  Chart  No.   14,  page  64. 


UNITED  STATES  TRADE  WITH  GERMANY 

1879     General  European  crop  failure. 

1887     U.  S.  crop  short. 

1891     Poor  harvest  in  Europe;  U.  S.  crop  largest 

on  record. 
1893     U.  S.  crop  small;  Europe's  large. 
1905-6     Good  crop  in  Europe. 

In  1920,  the  excess  of  exports  over  imports  from 
the  United  States  to  Germany  in  terms  of  money 
exceeded  all  precedents;  the  total  volume  of  the 
trade  with  Germany  was,  however,  smaller  not 
only  in  the  volume  of  goods  involved  but  also  in 
dollars  and  cents. 

Excess 
Imports.  Exports.  Exports. 

1914  ....$189,919,071  $344,794,276  $154,876,205 

1920  ....     88,836,280  811,437,377  222,601,097 


Comment  referring   to  Chart  No.  15,  page  68. 

THE   MERCHANDISE   BALANCE   OF 
FRANCE 

France  till  approximately  1875  was  an  export- 
ing country.  Since  that  time  she  has  been 
importing  more  than  she  has  been  exporting,  pay- 
ing the  deficit  with  the  returns  upon  her  foreign 
investments. 

1788     Failure  of  crop  in  France. 
1816     Harvest  failure  all  over  Europe. 
1862     General  European  crop  failure. 
1872     French  crop  large. 
1879     Crop  failure  in  France  and  all  over  Europe 

as  well. 
1882     Europe  produces  largest  crop  on  record. 
1885     French  crop  short. 
1891      Most  serious  shortage  since  1879. 
1893     Europe's  crop  large. 

1905  Large  world  crop. 

1906  World  crop  even  larger  than  that  of  1905. 
1911     French  crop  short. 


[lis] 


Comment  referring   to  Chart  No.   17,  page  77. 


THE  BRITISH  MERCHANDISE   BALANCE 

Great  Britain  was  an  exporting  country  until 
about  1863.  In  that  year  began  the  third  stage 
of  her  turning  from  a  protective  to  a  Free  Trade 
nation.  Since  then  the  United  Kingdom  has  been 
importing  more  than  she  has  been  exporting. 

1842     Crop  shortage  in  United  Kingdom. 
1874-77     Poor  crop  in  United  Kingdom. 
1879     Poorest  harvest  of  century  in  United  King- 
dom. 
1882     Europe  produces  largest  crop  on  record. 


Comment  referring  to  Chart  No.  18,  page  81. 

PUBLIC  DEBT  OF  GREAT  BRITAIN 

1815     End  of  Napoleonic  War. 
1854     Crimean  War. 
1898-1900     Boer  War. 
1914     Outbreak  of  Great  War. 

PUBLIC  DEBT  OF  FRANCE 

1871     Franco-Prussian  War. 
1914     Outbreak  of  Great  War. 

Comment  referring  to  Chart  No.  19,  page  84. 

PUBLIC  DEBT  OF  UNITED  STATES 

1812-15     War  of  1812. 
1848     War  with  Mexico. 
1861-65     Civil  War. 
1898     Spanish-American  War. 
1917     Entry  into  Great  War. 

PUBLIC  DEBT  OF  GERMANY 

1870-71     Franco-Prussian  War. 
1914     Outbreak  of  Great  War. 


[116] 


TABLES 


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41.125 
22.00 

89.00 
33.00 
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17.63 
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$  4.7677 
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120.00 
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[124] 


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OVERDUE.  ^___:^-:=n:::r: 


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